Yesterday we started to peel back the onion of economic crisis response, including the Monetary Policy that Central Banks employ. 

Today, we’ll start by digging into the everlasting joys of Fiscal Policy that Governments employ to try and keep economies afloat during the best of times, and the worst of times.

So, the first thing to know is that Fiscal Policy is basically the policy of the government around how much it will tax who and what it will spend where.

Generally, a government will utilize a Contractionary Fiscal Policy, which is when a government decides to tax its citizens and its businesses more than it will spend in its budget.

This is normally a good idea during a period of strong economic prosperity in the same way that it’s normally a good idea for you to not spend every penny you make and set aside some money to build up a savings account or even invest into a portfolio. The same general rule is true for entire nation, but the good times are over now — so it is time to turn everything around and enact Expansionary Fiscal Policy.

Now this is the good stuff.

Expansionary Fiscal Policy basically means that you tax less than what you spend, but that is a very, very basic way of looking at it.

The main difference between Fiscal Policy that governments use and the Monetary Policy that Central Banks use is that, as we talked about yesterday, Monetary Policy is slow and doesn’t do much to slow the type of sudden crisis we find ourselves currently in.

That’s where Expansionary Fiscal is better equipped.

There are often hundreds of types of different taxes in most modern nations from general stuff like income tax, business tax, land tax, sales tax to really specific things like liquor taxes. If you are a government playing around with Fiscal Policy, you get to pick and choose what taxes to lower. You might say, well, businesses are having a hard time right now, so maybe we will just lower their business taxes for this year or whatever works for that specific scenario.

The other thing about Fiscal Policy is that it is really fast acting. If you were to lower income taxes effective immediately, people will feel that from their very next paycheck. Trust me, if people feel even just a little bit richer, you better believe that they are going to go out and spend that little bit of extra cash hitting their account on a Friday night.

Governments also get to splash some cash. Already we’re seeing major countries like the US give every tax paying resident (who made less than $75,000) a direct check for $1200 as quick as possible.

This is called fiscal stimulus.

The hope of this policy that it will get people to go out and spend some money on a new TV or a new couch or whatever. This spending means more people will have jobs and those people with jobs can go out and spend a salary they might not have otherwise had — and so the cycle repeats itself. This overall impact of money being spent leading to more money being spent is called the multiplier effect.

For example, the multiplying effect of giving money directly to an average citizen is pretty high because, let’s be honest with ourselves, most people spend a good majority of the money that hits their bank account pretty much straight away.

That’s why, even though Helicopter Money was something we were questioning the validity of a few month ago, we’re seeing the fiscal bazooka starting to shower people with money.

The hope is that it walks people away from the cliff of fear and back towards the land of greed.

As we consider other avenues for stimulating real growth real fast, potentially a more reasonable type of fiscal stimulus is infrastructure spending. This is using government money to build a new bridge or a highway or an airport or whatever. This still gets money into people’s pockets to be spend because it normally takes a big workforce to make these sorts of projects happen and you get the added benefit on top of this of actually having a piece of infrastructure after all that spending is done.

Perhaps the most famous example of this in modern history was The New Deal — a series of programs, public work projects, financial reforms, and regulations enacted by President Franklin D. Roosevelt in the United States between 1933 and 1939 to try and bring the US back from the Great Depression.

Some parts of the New Deal worked; some did not. The New Deal restored a sense of security as it put people back to work. It created the framework for a regulatory state that could protect the interests of all Americans, rich and poor, and thereby help the business system work in more productive ways.

And therein lies the issue with infrastructure spending for stimulus: the multiplying effects are not quite as strong. Sure, there will be laborers and trades people and engineers to construct these projects, but a good portion of that money will also go into construction companies that tend to hold that profits a little bit more tightly during these trying times. The other thing with infrastructure spending stimulus is that it is comparatively slow. By the time a new highway is planned and zoned and engineered, the economic downturn might have already been and gone with the damage done.

I remember seeing these signs in 2010 and thinking how odd it was that a government program needed to justify itself so loudly.

The American Recovery and Reinvestment Act of 2009, nicknamed the Recovery Act, was an economic stimulus package (aka Fiscal Policy 101) estimated to be $787 billion at the time of passage, later revised to $831 billion, and was meant to save existing jobs while creating new ones as soon as possible. Other objectives were to invest in infrastructure, education, health, and renewable energy.

The rationale of such egregious spending lies at the heart of Keynesian economic theory — that, during recessions, the government should offset the decrease in private spending with an increase in public spending in order to save jobs and stop further economic deterioration.

We’ll undoubtedly see something similar to The New Deal and the Recovery Act, though I imagine it will dwarf the other two in size and spending.

So, with a combination of Monetary and Fiscal policy, we will save the day and capitalism will go back to humming along, right?

Well, that shows you the greatest problem with all of these measures.

Everything we have explored so far has been about getting people out there spending money during an economic downturn. But, what if your economic crisis is on the supply side?

What if, hypothetically, something has caused factories to shut down, airplanes to stop flying, and ships to stop shipping? This is something that doesn’t necessarily cause problems on the demand side of the equation, but what it does mean is that, even if people did want to go out and shop for things, they may not have anything to shop for. This is a much, much harder problem to deal with as a government.

For starters, if supplies dry up, it increases the price of goods. That’s okay in moderation, but too much causes runaway inflation as people desperately outbid each other for that last roll of toilet paper.

This all but makes monetary policy useless because if there is already inflation, you are not going to solve any problems by causing more inflation, which means the attention turns exclusively to how governments keep business alive, which causes problems in and of itself.

Ah, so now we finally turn to the gods of business: corporations.

After all, we can’t talk about the economy and how to fix it without talking about the largest contributors of economic supply.

Major corporations are one of the largest influences on modern economies today. They often employ tens of thousands of people and provide services that are all but crucial to our modern way of life.

And the thing is: they know it.

CEOs of these mega corporations really have one primary goal: maximize the return for shareholders of the company, and more specifically maximize the return of shareholders in the short-term given the ways corporate CEO bonuses are normally structured.

So, let’s say that you’re such a CEO. You’ve had a record year of profits complimented by a very generous reduction in corporate taxes (as was the case in 2018).

As a result, you find your company stuffed with a lot of cash. This gives you three options:

You can save this money into a corporate equivalent of an emergency fund.

You could reinvest it into growing the firm.

You could use this wealth to issue share buybacks and massively inflate the value of the company.

As we know, most CEOs and companies opted for #3, as it helped drive their stock price to new astronomical heights. These inflated shares and the buybacks that helped them get there actually achieve the goal of a corporate CEO, which again is to increase the returns of shareholders.

Now, some companies did reinvest their record profits, but what most did NOT do is hold free cash in an emergency fund. Why is that?

Well, money sitting around is money not making more money, of course. It certainly won’t make the shareholders more money, as well, so the CEO will be fired if they took such a conservative approach to free capital.

But you know the real reason why corporations simply don’t save for emergencies?

Why, after only a month of slowed business, major corporations are begging for bailouts and other aid from the government?

Because they know they’ll get it.

Corporations know they’ll get bailed out.

They know the Fiscal Policy of the government simply cant let major job producing entities go bust because the whole reason they’re giving people money is so they spend it and keep people employed.

If major employers go down with the economy, it removes much of the government’s arsenal of fighting a downturn.

And so, the bailouts continue.

We’ll discuss this more tomorrow.