Written by Ryan Erickson
Apart from changing how we teach (as we’ve become students of Zoom University), the current COVID-19 pandemic could also impact what we teach in the future, specifically in economics courses. This would come on the heels of Econ curricula seeing tweaks in light of the Great Recession of 2008-09. What made the Great Recession different was the Fed’s go-to move of cutting interest rates was not enough. Nominal rates hit zero in December 2008 but the strength of the crisis was too large (Federal Reserve Economic Data). So the Fed pursued unconventional measures, known as quantitative easing, and in the process, expanded its balance sheet by trillions of dollars—a previously unthinkable figure (Federal Reserve Economic Data). One of the most widely-used textbooks for introductory macroeconomics, Macroeconomics by Olivier Blanchard and David Johnson, saw significant revisions after the Great Recession. Among the changes listed by Blanchard is scrapping the aggregate supply-aggregate demand (AS-AD) model. This was in large part because the model assumes a constant “nominal money supply” in its movements (Blanchard). But due to quantitative easing, this was not the case during the Great Recession (Federal Reserve Economic Data). The AS-AD model also happens to be the main model taught to explain recessions in ECON 102 here at Michigan, the highest macroeconomics course taken by many students, especially if they are non-Econ majors.
Fast forwarding to our current pandemic recession. One economic measure that could give us a clue to how Econ courses could change is the personal saving rate, which recently spiked to historic levels, topping 30 percent in April (Federal Reserve Economic Data). This rate is personal saving divided by disposable personal income (DPI), so as a fraction, it can increase by personal saving going up or DPI falling.
In this case it is a higher numerator—or personal saving increasing. In fact, since DPI also went up, reflecting government aid such as the stimulus checks and the $600 weekly federal unemployment bonus from the CARES Act, personal saving soared (Federal Reserve Economic Data). To clarify, personal saving is measured as disposable income that is not spent (Bureau of Economic Analysis). Thus, saving as we typically know it—depositing money into an account, or since much of the relief aid was distributed by direct deposit into accounts, not spending one’s aid money—could explain this. But paying off debt, which is effectively reducing negative saving, is also a possible explanation.
Related to temporary transfers and saving, a commonly taught Econ concept (including in intermediate macroeconomics at Michigan, ECON 402), is the theory of Ricardian equivalence. The theory, first proposed by British economist David Ricardo, is that consumers are forward-thinking and take into account that the government must eventually balance its budget. This means a temporary transfer or tax cut to consumers now is not viewed as extra income and is thus saved because they know they will ultimately have to pay it back to the government through future taxes.
Evaluating this theory, the premise of governments ultimately having to pay off debt is not realistic since the federal government can borrow through the Treasury in negative real terms (Federal Reserve Economic Data). Negative real terms mean that the federal government can borrow at a rate lower than inflation, effectively allowing them to borrow indefinitely. Additionally, more direct papers that test this theory, such as Shapiro and Slemrod (2009) which surveyed how stimulus checks from the Economic Stimulus Act of 2008 were spent, show that some portion (20 percent in the 2008 case) spend these temporary payments, with most saving or paying off debt. This thinking technically refers to the permanent income hypothesis: consumption decisions are primarily determined by lifetime income and temporary bumps, such as stimulus checks, get smoothed out and have little change. Ricardian equivalence is a consequence of combining this hypothesis with government borrowing. The initial results on this year’s round of stimulus checks from the CARES Act, which were sent out starting in April, are in line with the previous findings: most individuals “primarily saved or paid down debts” and “only about 15 percent” spent most of their stimulus checks (Coibion, Gorodnichenko and Weber). This also agrees with the skyhigh personal saving rate mentioned earlier, with these transfers in large part being saved.
Nevertheless, this result contains more nuance. First, “primarily saved or paid down debts” implies that recipients saved the majority of their stimulus checks but not necessarily all of them. So a portion of them could be consumed even for someone who primarily saved. In fact, “approximately 40 percent” of the checks in total were spent (Coibion, Gorodnichenko and Weber). Thus, while individual results point to “mostly saving,” their aggregation shows a lot of the money being spent. This is counter to the permanent income hypothesis and Ricardian equivalence, which would predict hardly, if any, of the checks to be consumed. Also, we need to address a normative component here. While findings of “mostly saving” make it sound like the policy is ineffective, partly because we expect aid like this in recessions to be spent and function as a stimulus to support demand, this tells an incomplete story about the human impact. The pandemic threw millions into economic turmoil, and regardless of how those afflicted used their checks, the transfer represented a much-needed lifeline for them. This perspective is well conveyed by Claudia Sahm, policy analyst and PhD in economics from Michigan (2007), whose Twitter thread helped me in research for this writing (Sahm). Per Sahm’s Twitter, she is formerly a leading economist at the Federal Reserve. She now aims to reform the economics field through making more of research based on people (such as surveying them) rather than theory, as well as combatting toxicity and discrimination within the economics discipline.
Thus, when it comes to teaching, in addition to updating theories now rejected by empirical research, we also need to broaden our definition of success in economic policy. Success in economic policy should involve maintaining the welfare of the American people when there is no immediate solution for strengthening the economy—as is the case currently. The American populace alone cannot spend its way out of the COVID-19 recession like it did in previous recessions, such as the dot-com bubble of the early 2000s. Instead, our country must now wait for a vaccine while the Federal Reserve and federal government act to keep the economy afloat.