Thread by @ojblanchard1

Let me double down and go through some numbers. I agree that too much is better than too little and we should aim for some overheating. The question is how much. Much too much is both possible and harmful. I think this package is too much.

Let’s look at the numbers. Size does matter and can be assessed.
If the economy had continued on its pre-covid trend, it would be about 900 billion dollars larger. This suggests an output gap of less than 900 billion as some sectors will not operate at full speed for some time.

(CBO’s gap is 480 billion.) But let’s take 900 billion as the upper bound.

Thanks to CARES and given worries about the pandemic, most Americans saved far more in 2020 than usual. Excess saving was around 1.6 trillion. As conditions improve, consumers will spend some fraction of it this year. If we say half, that’s 800 billion in additional spending

CARES added 900 billion of stimulus in December. The Biden proposal adds 1.9 trillion. The infrastructure program to come, will add more, but let’s leave it aside. Adding the three numbers above gives: 3.6 trillion or 4 times the upper bound on the output gap.

How this number translates into an increase in demand this year depends on multipliers. If the average multiplier is 1 (which I think of as a conservative assumption), this implies that demand would increase by 4 times the output gap.

If this increase in demand could be accommodated, it would lead to a level of output at 14% above potential. It would take the unemployment rate very close to zero.

This would not be overheating; it would be starting a fire.

If it were to happen, it would lead to strong inflation (not the 2.5% that some predict, but potentially much more), and, likely a strong reaction of the Fed to limit the overheating, a very large increase in interest rates, again far more than is currently priced in.

Why go there? Why force the Fed to in effect cancel some of the Biden package?

Could I be wrong and too pessimistic? Sure. Multipliers could turn out to be very small, maybe 0.25. I see no strong reason for it.

Potential output could be much higher, say half a trillion higher. I see no strong reason for that either. Or demand may be very weak for other reasons. Again, I do not see why. But it could happen, and everything would turn out fine. The question remains: Why take the risk?

Let me be clear. We should spend what we need to save people from poverty and fund the needed response to the pandemic. I think we do not need to spend 1.9 trillion for that, and we should have a smaller program. But suppose we did need to spend that.

Why couldn’t we finance it partly by an increase in taxes, say an exceptional tax on capital gains, given that the stock market has done so well in the recent past? This would be fair, deliver protection and limit overheating. Wouldn’t this be a better way?