Why Europe should spend big like Biden by Christian Odendahl and John Springford
A big macroeconomic experiment is underway in the US. The $1.9 trillion fiscal package, agreed by Congress in March, sits on top of December’s $900 billion commitment, bringing total new spending to $2.8 trillion. In addition, the Biden administration is planning to invest a further $3 trillion in infrastructure and education (although some of this will be financed by tax hikes). Not all of the $2.8 trillion is short-term stimulus – much of it consists of measures that would be considered the normal operations of a welfare state in Europe, such as income support to help households pay their bills while COVID-19 restrictions continue. But in all, this amounts to a big jump in debt-funded US government spending, which should raise growth significantly in 2021. The ‘Biden plan’ is not without its critics, even on the progressive side of the political spectrum. Larry Summers, former Treasury secretary under Bill Clinton, argues that it will raise inflation because government spending will be two times larger than this year’s output gap – a standard but controversial measure of the extent to which an economy is running below capacity. Those defending the Biden stimulus insist that big spending is needed as the extra income support will mostly help people whose finances have been badly damaged by the pandemic. The US economy is also far smaller than would have been predicted a decade ago, making it
unclear what the true capacity of the economy really is. Its potential might be quite a bit higher than the output gap measure suggests, lowering the upward pressure on wages and reducing the risk of runaway inflation. From an economic perspective, it is clearly more risky to do too little than too much: the Federal Reserve can always tighten monetary policy if government largesse sets off an inflationary boom, while slow growth and low inflation can become a trap, as Europe’s last decade shows. The OECD reckons that growth in the US will be 6.5 per cent in 2021, compared to the eurozone’s 3.9. Both are forecast to grow at around 4 per cent in 2022. That means that, at the end of 2021, the US is projected to return to the level of output that the OECD had forecast before COVID-19 emerged, while the eurozone economy will be 4 per cent smaller. There are two reasons why the economic recovery in Europe will be slower. First, the rollout of vaccines in Europe is roughly six weeks behind the US. As of late March, the EU had