The "Fiscal Cliff" Scenario.

At some point, the federal stimulus checks will stop coming. Consumer sentiment could continue to be affected by fear of further Covidrelated complications. The world economy hardly looks trouble-free. Is it possible that U.S. policymakers fired all their fiscal stimulus cannons too soon? Will they be short of ammunition in the event the economy in 2022 significantly underperforms? Some economists, using a different metaphor, describe the danger as "running head-on into a fiscal cliff." To what degree should U.S. policymakers be concerned? The economy was already rebounding. Should policymakers have held back on sending out the checks until 2022?

Twenty noted observers rate the risks.

SCOTT BESSENT

Founder, Key Square Group, and former Adjunct Professor, Yale College

Medical researchers largely group Covid-19 patients in three categories: asymptomatic, regular Covid, or long haulers. If we bring this trio of classifications to the economic realm, it is clear that no country's economy could be considered asymptomatic. Around the globe, fiscal and monetary authorities treated their economies as though they had regular Covid: shock therapies of monetary easing, massive and often repeated fiscal transfers, and corporate bailouts. Now, for the United States, we must examine whether having survived the early economic cytokine storm, a continued malaise similar to long Covid will set in. Also important is whether the policy doctors have new treatments in their tool kit to treat this ailment or whether we must just wait for it to run its course.

As with so many parts of our daily lives and professions, Covid has challenged foundational assumptions, adding new variables to longstanding patterns. The nature of the virus and associated shutdowns have led to production shortages and bottlenecks across the global supply chain. In addition, work from home and Covid anxiety have caused workers to retreat or retire from the workforce, resulting in employee shortages. Finally, long-dormant price pressures have emerged at an inconvenient time to squeeze real wages and dampen animal spirits.

Overall, the U.S. economy has learned to live with the virus. Mobility data shows that the Delta variant has not caused a retreat from the already undertaken reopening patterns, but it has likely slowed the pace of the reopening, inventory restocking, and service sector hiring. What looked like a potentially runaway economy in the second half of 2021 will now certainly see a deceleration toward the end of 2021 and into 2022 as the surety of government transfers is replaced by an improving but tentative private sector recovery. Even as an increased prevalence of antibodies in the U.S. population controls outbreaks, shortages will continue to inhibit economic growth. This is the first time in thirty years that I have observed supply constraints, rather than demand declines, causing PMIs to retreat.

For 2022, it is unlikely that the United States will hit an economic air pocket that takes the economy into recession. Rather, the balance of probabilities favor an uncomfortable mix of sticky inflation and below trend growth. Policymakers, having rescued the patient using shock therapy in the acute phase, will have limited room for maneuvering.

Increased levels of government spending and the commensurate additional debt are polling poorly with American voters, especially independents. Next year--2022--is a mid-term election year, making it unappetizing for swing-district members of Congress to layer on the already massive but drawn-out spending packages slated to pass during the remainder of 2021. The Federal Reserve, having signaled that it will begin to taper quantitative easing in the coming quarters, is unlikely to reverse, or even pause, barring a serious economic downturn.

The real dilemma is not the fiscal cliff of 2022, but the downshift in the real growth trajectory of the United States in the post-Covid years.

The views presented in this article are purely the opinions of the author and are not intended to constitute investment, tax, or legal advice of any nature and should not be relied on for any purpose.

JOSEPH E. GAGNON

Senior Fellow, Peterson Institute for International Economics

The Covid-19 pandemic prompted the fastest increase in U.S. federal spending since World War II. The budget deficit soared to 15 percent of GDP in 2020 and remains in double digits this year. No set of policies could have prevented a sharp recession last year, as consumers and workers sheltered at home while businesses adapted to massive shifts in spending patterns. But most households received federal aid that fully compensated them for lost labor income, helping to prevent a cascading drop in overall demand and enabling the most rapid economic turnaround ever recorded.

The fiscal deficit is projected to shrink rapidly next year, even if Congress passes the large physical and social infrastructure bills currently being negotiated. Some may worry that the drop in federal spending will tank economic activity. However, the large bulge in household savings carried over from last year, booming house and stock prices, the strong condition of state and local government finances, and easy monetary policy should support continued economic growth.

The biggest risk arises from Covid-19. The current Delta wave of infections has had less of an economic impact than previous waves. If the Delta wave declines in the autumn, as many experts are predicting (as of August 2021), pent-up demand should continue to support a strong recovery and employment should return to, or beyond, its pre-pandemic peak next year.

On the other hand, if delays in booster shots or a new variant causes the pandemic to take a turn for the worse, private spending might not fill the fiscal gap. In that case, a new round of income support would be needed.

With federal debt having risen from 80 percent to 100 percent of GDP in just two years, are there grounds to worry about the U.S. government's ability to finance further income support? Absolutely not. The record low level of interest rates on federal debt amply demonstrates that financial markets are begging the government to borrow more. Japan shows that even larger debt ratios can be supported indefinitely.

Could interest rates jump unexpectedly and cause problems for future administrations? The most comprehensive studies suggest that demographics will keep the equilibrium real interest rate low for years to come. Moreover, the main likely cause of any surprise future rise in real rates--higher productivity growth--would be welcome news that would simultaneously boost tax revenues to service debt. Another possible driver of higher interest rates--surging inflation--would be at most a temporary phenomenon that the Fed knows how to control. We are far from any fiscal cliff.

JOHN B. TAYLOR

George P. Shultz Senior Fellow in Economics, Hoover Institution, Mary and Robert Raymond Professor of Economics, Stanford University, and former Treasury Under Secretary for International Affairs

We have seen government deficits bulging to over 13 percent of GDP, federal debt skyrocketing to over 100 percent of GDP, and the Federal Reserve purchasing gigantic amounts--$120 billion per month--of Treasury securities and mortgages. And economic growth is rapid as we have emerged from the pandemic-driven recession of 2020. The high growth and big deficits have led many to believe that there is simply no reason to worry about deficits. The federal government can just keep spending and bond buying with no danger of running out of ammunition should there be another pandemic or reason for a recession.

But basic economics and real-world lessons suggest otherwise. Between March 2020 and March 2021, the United States enacted three fiscal packages which raised the deficit with the hope of stimulating the economy. President Trump signed one package into law on March 27, 2020, and another on December 27, 2020. President Biden signed a third on March 11, 2021.

Each piece of legislation paid funds to people with the hope that they would spend the increased income and stimulate the economy. The rationale was Keynesian: that any increase in income boosts the economy. But alternative proven views, such as Milton Friedman's permanent income hypothesis, say that such temporary increases in income do not stimulate the economy.

In fact, data and economic models show that the so-called stimulus payments in the legislative packages were saved and did not stimulate, just as the permanent income model predicted. Instead, the economy recovered as Covid-19 vaccines were discovered and applied, and private businesses started opening again and hiring people. A challenge now is to reverse these deficit-increasing actions and commit to a sound fiscal policy in the near future. This is needed for a strong recovery driven by the private sector. If an agreement could also be made to lower the growth rate of government spending and to keep tax rates from rising, then the policy will be more powerful. And the United States would be in better shape should a recession emerge again.

Government spending should be aimed at helping people directly affected by the pandemic and at particular problems in the economy, including needed infrastructure projects. A fiscal consolidation policy--rather than gigantic deficits--will lead to stronger growth. And if there is another economic downturn, we will have both a stronger economy and a deficit under control. We would therefore have the wherewithal to combat any recession by a predictable counter-cyclical tax reduction and spending increase, letting the deficit grow in a predictable way for a shorter period. That is the kind of ammunition we need now in the U.S. economy.

ROBERT J. BARBERA

Director, JHU Center for Financial Economics, and Economics Department Fellow, Johns Hopkins University

No one can deny the dramatic expansion of U.S. federal...