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The COVID-19 Pandemic of 2020-2022 (C): Fiscal and Monetary Stimulus

The COVID-19 Pandemic: Fiscal and Monetary Stimulus

Encyclopedia: Money and Credit

The circumstances of the COVID-19 pandemic as outlined in part (A) of this case study prompted dramatic responses in government policy. In early March, credit markets in the U.S. and internationally nearly froze, reflecting a massive “dash for cash”: most investors sought to sell assets and few sought to buy. The trading imbalance meant that businesses, governments, and individuals found it impossible to meet their credit needs. The U.S. Federal Government responded with innovations in fiscal and monetary policy. This massive program dwarfed many previous responses to economic crises and was the most comprehensive stimulus program enacted in a short time in U.S. history (see Exhibit C1).

Monetary policy. The U.S. Federal Reserve System flooded financial markets with liquidity. From March 11 2020, to 2022, the U.S. Federal Reserve (“Fed”) purchased $4.06 trillion in Treasury securities and mortgage-backed securities; it added $447 billion in liquidity through repurchase facilities and central bank dollar swap lines; it extended $110 billion to small businesses through the Paycheck Protection Program; and it loaned $54.6 billion through various lending facilities to municipalities, medium-size businesses, money market mutual funds, and to primary dealers in government securities. Finally, the Fed cut the benchmark Federal Funds Rate to near zero and reduced reserve requirements to banks to zero. In all, the change in the Fed’s monetary policy, committing $4.67 trillion in funds, was the fastest and largest in central banking history (see Exhibit C2).

Fiscal policy. In 10 acts of law,1 the U.S. Congress disbursed $5.47 trillion to offset the impact of nationwide lockdowns, which when combined with $814 billion disbursed through presidential executive orders and other administrative orders, amounted to a total of $6.28 trillion. In absolute size, the spending dwarfed all previous responses to economic and financial crises. According to national income accounting, increases in government spending (net of increased tax revenues) would increase the output of an economy, or Gross Domestic Product (GDP):

GDP = C + I + G + NX

Where C is private consumption, I is private investment, G is net government spending, and NX is net exports. As the equation shows, an increase (decrease) in G will expand (contract) output.

Funding. The fiscal stimulus entailed virtually no tax increases and several tax decreases and deferments. Therefore, the stimulus relied upon issuance of debt by the U.S. Treasury (see Exhibit C3). Of the $6.28 trillion in stimulus spending, the Federal Reserve purchased $2.7 trillion in Treasury securities, which in combination with the Fed’s reduction in interest rates, implied a partial monetization of the stimulus program. Monetization was not without precedent, having been practiced by the U.S. Treasury and other governments during wars and other national emergencies.

Constraints on Fiscal Stimulus and Monetary Growth?

The COVID pandemic prompted some policy analysts and public officials to advocate a broader program of fiscal spending and debt monetization. They argued that the country faced limitless calls for spending to address priorities such as climate change, aging infrastructure, national security, and economic inequality. At the same time, prevailing interest rates in the market were at all-time lows. The causes of low interest rates were the focus of active debate, yet they stimulated the view that at low interest rates, government deficits do not matter, particularly for countries that borrow in their own currencies.2

Writing before the pandemic, MIT economist Olivier Blanchard (2019) held that when the interest rate (R) on safe government debt fell below the nominal growth rate of the economy (G), governments no longer face an intertemporal budget constraint—that is, they can borrow freely from future generations to finance current projects. Economist Stephanie Kelton (2021) extended this reasoning to propose that the U.S. government should issue and monetize debt without limit. In other words, the U.S. government should finance itself from the Fed—and embark on a program of policy activism not seen since the 1930s. Kelton’s “Modern Monetary Theory” played an important role in helping to justify the $1.2 trillion infrastructure bill of late 2021, and the proposed but not enacted $2 trillion Green New Deal bill. As Ruchir Sharma, chief global strategist at Morgan Stanley Investment Management wrote, “They believe that they can easily borrow to pay for it all because the last four decades of easy money have brought interest rates to near or less than zero: Money is free.”3

On the other hand, “debt hawks” strongly opposed large fiscal deficits and debt monetization. First, they argued that over time, interest rates have tended to be lower (not higher) than the growth rate of the economy. Thus, historically, interest rates that fell below the growth rate of the economy were brief and infrequent. Second, if the country issued a lot of new debt when interest rates were low, it would face a crushing financial burden when interest rates rose. Third, critics worried that too much government borrowing would “crowd out” private sector borrowers in the credit markets, and thus constrain economic growth. Fourth, reliance on excessive debt finance was associated with financial instability. A study by economists Carmen Reinhart and Kenneth Rogoff (2010) found that countries were more prone to slow growth and even financial instability if their debt exceeded 90 percent of GDP.4 And finally, debt hawks said that aggressive fiscal and monetary policies prompted inflation in prices.


Milton Friedman, a champion of Monetary Economics, had famously said that “Inflation is always and everywhere a monetary phenomenon,” meaning that inflation tended to follow material increases in the money supply. Other economists, such as Nouriel Roubini, argued that fiscal, not monetary, policy was the source of inflation.5 Thomas Sargent, another Nobel Laureate in Economics, argued that “Persistent inflation is always and everywhere a fiscal phenomenon.” Sargent’s assertion was part of a larger movement among economists toward the Fiscal Theory of the Price Level (FTPL). This theory asserted that fiscal and monetary policy are linked and that the central bank will tend to respond to fiscal deficits by printing more money.

Yet from 2008 to 2019, massive increases in the money supply by the Fed had yielded scant increases in inflation. The Fed’s policy of “quantitative easing” from 2008 to 2015 had added $3 trillion to the money supply of the U.S., though consumer price inflation in the U.S. had remained relatively low (an average of 1.8% per year from 2010 to 20196)—this prompted many observers to conclude that the link between money supply and inflation had ended. However, economist Greg Mankiw (2020) said that analysts needed to look at the association between money supply and inflation over the long term, not short term—from 1870 to 2022, he found a 79% correlation between the two.

By early 2022, prices began to rise more sharply at annual rates of 7.5%, 7.9% and 8.5% in January, February and March, respectively. Inflation expectations appeared to be forming. Prices for gasoline, food, and transportation rose even faster.

Optimists argued that inflation had waxed and waned since the end of World War II and that the current inflation rates were only temporarily high. They believed that rising inflation was due to supply shocks associated with broken global supply chains and that when supply chains were repaired, inflation would subside. Modern Monetary Theory adherents dismissed inflation as a problem for American society.
Pessimists feared the onset of serious inflationary forces that would take years to quell owing to inflationary expectations among the American public: if individuals believed that prices would increase rapidly, they tended to behave in ways that created a self-fulfilling prophecy, for instance, through hoarding or heightened demand for increased wages. The pessimists argued that inflation distorted decision-making about resource allocation, market pricing, and employment, and that it triggered wealth transfers from creditors to debtors and from the wealthy to the poor. Also important was that voters tended to penalize elected officials following rising inflation.


  1. Compare recent levels of U.S. government debt to GDP in Exhibit C3 with the finding of Reinhart and Rogoff (2010) that at levels above 90%, “are associated with notably lower growth outcomes.” 7What are the implications for U.S. GDP growth following the COVID pandemic?
  2. Consider the practicality of the Blanchard-Kelton suggestion that when R < G, a government can borrow without limit. From the history of Treasury bond yields and U.S. growth rates, found in Exhibit C4 in the spreadsheet, “COVID2020 STUDENTv21.xlsx,” how often has been R < G?
  3. Critically assess the relationship between consumer price inflation on one hand, with the changes in fiscal stimulus and money supply (M2).
    1. From data in Exhibit C5 (also see the spreadsheet, “COVID2020 STUDENTv21.xlsx”) graph the time series of fiscal stimulus (growth rate of government debt)8, monetary stimulus (growth rate of money supply, “M2”), and the consumer price index (CPI). Do you observe a relationship of fiscal and monetary stimulus with consumer price inflation?
    2. Compute the correlation coefficient for each pair of data. Is it large or small? Following Greg Mankiw’s suggestion, look at a long time series of monthly data, such as December 1958 to March 2022—Exhibit C5
    3. includes this data range (see COVID2020 STUDENTv21.xlsx.)
    4. Maybe inflation does not occur immediately after an increase in government spending or Fed asset purchases. Try lagging the CPI series by 6, 12, 18, and 24 months—do the correlation coefficients change materially from what you found with no lag?
  4. Interpret. Why might inflation be associated with government spending and Fed asset purchases? If you observed a lagging effect, why might that occur?


Exhibit C1

COVID RESPONSE Allowed Disbursed Ratio:Disbursed/Allowed
Federal Reserve Disbursements
Asset Purchases $4,060.0 $4,060.0 100%
Liquidity Measures $2,140.0 $447.00 21%
Other Loan Purchase Programs $806.00 $110.00 14%
Lending Facilities $141.00 $54.60 39%
Federal Reserve, Total‡* $7,147.0 $4,671.6 65%
Legislative Spending
Loan and Grant Programs $1,560.0 $1,410.0 90%
Income Support $925.0 $876.0 95%
State & Local Funding $904.0 $861.0 95%
Direct Payments $869.0 $823.0 95%
Health Spending $748.0 $592.0 79%
Tax Policy $568.0 $523.0 92%
Other Spending** $454.0 $371.0 82%
Legislative, Total $6,028.0 $5,456.0 91%
Administrative Spending (Executive Order)
Trump Administration $605.0 $484.0 80%
Biden Administration $355.0 $324.0 91%
Administrative, Total $960.0 $808.0 84%
Total: Fed, Legislative, Administrative $14,135.0 $10,935.6 77%
Total: Legislative, Administrative $6,988.0 $6,264.0 90%

‡ The total for Fed “allowances and disbursements” ignores the impact of monetary policy actions such as cuts in Federal Funds Rate and reduction in reserve requirements.

*Note that virtually all of the Fed commitments were in the form of loans and investments (for which the return of capital could reasonably be presumed), rather than “spending” in the sense of Congressional authorizations. For this reason, the total of all commitments are presented two ways: with, and without Fed commitments.
**Congress committed $456 billion to enlarge the Exchange Stabilization Fund, which was used to backstop Fed loan programs under Section 13(3).

Source: Author’s table derived from data presented in “Track the COVID Money,” Committee for a Responsible Federal Budget, accessed October 3, 2022 from https://www.covidmoneytracker.org/.


Exhibit C2

Exhibit C3

Exhibit C4

Exhibit C5


1 Congressional acts to respond to the COVID pandemic included the American Rescue Plan, CARES Act, Coronavirus Supplemental Appropriations, Emergency Aid for Returning Americans Act, Families First Act, PPP & Health Care Enhancement Act, Prevent Cuts Act, Protecting Medicare Act, Response & Relief Act, September 2020 Continuing Resolution, and September 2021 Continuing Resolution.

2 Some people argued that since the financial crisis of 2008, people had sought to build reserves against possible future instability, which produced a savings glut, with the savings invested in the stock and bond markets. As demand increased, prices rose, and bond yields declined. It appeared, for instance, that the boom in stock prices (especially the boom in “meme stocks” such as GameStop and AMC) in January 2021 reflected the inflow of CARES Act social safety net payments—in other words, the public did not spend the payments and instead used them to invest in financial assets. Another contributor to low interest rates was the accommodative monetary policy by the Federal Reserve that sought to restore economic growth and employment to higher rates by lowering interest rates.

3 Ruchir Sharma, July 25-26, 2020, “The Rescues Ruining Capitalism,” Wall Street Journal, page C1

4 The tipping point was presented in Reinhart-Rogoff, 2010. “Growth in A Time of Debt” American Economic Review. Subsequent study of the database (Herndon, Ash, and Pollen, 2013. “Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogoff,” Working Paper, University of Massachusetts Amherst at /http://peri.umass.edu/fileadmin/pdf/working_papers/working_papers_301-350/WP322.pdf) revealed a coding error, which when corrected, moderated the severity of the result. Above 90% debt-to-GDP, annual growth declines but does not turn negative. Still, the influence of high government debt is to depress the rate of economic growth.

5 Roubini and Backus, Chapter 6.

6 CPI Inflation Calculator, downloaded April 22, 2022 from https://www.in2013dollars.com/2010-dollars-in-2019amount=15300&future_pct=0.0167#:~:text=The%20dollar%20had%20an%20average,rate%20in%202010%20was%201.64%25.

7 Reinhart and Rogoff (2010), 577.

8 One measure of fiscal stimulus is the percentage growth rate of government debt. This recognizes that “unfunded spending” (that is, spending not funded by taxes) is stimulative to the economy. Unfunded spending is by definition financed by the issuance of debt. Deficit spending (stimulative fiscal policy) increases the stock of debt. Using the growth rate of government debt as a measure of fiscal stimulus has at least two advantages. First, it avoids the debate over whether “deficit” should include accrued obligations owing to long-term budget commitments. The growth rate in debt is a reasonable estimate of the cash fiscal stimulus by government. Second, it includes the impact of any debt repayment or refunding operations by government. Conventional measures of fiscal deficits exclude changes in debt. For more discussion about the challenges of defining a fiscal stimulus, see Mario I. Blejer and Adrienne Cheasty, 1992. “How to Measure the Fiscal Deficit: New Thinking on Alternative Fiscal Deficit Measures,” Finance and Development, International Monetary Fund 0015-1947-article-A013-en (1).pdf at www.imf.org/external/pubs/ft/pam/pam49/pam4902.htm.