Beyond BLS

Beyond BLS briefly summarizes articles, reports, working papers, and other works published outside BLS on broad topics of interest to MLR readers.

June 2023

Can stimulus checks pay for themselves?

Summary written by: Harry Nitzberg

During the COVID-19 pandemic, the U.S. government issued stimulus checks to support demand and keep the economy afloat. To pay for the stimulus, the government increased its annual budget deficit and, by extension, increased its total debt. Logically, the debt that the U.S. government incurred to pay for the stimulus checks will need to be eventually paid off by higher taxes. Yet, an emerging body of work suggests that this might not be entirely true. In their article “Can deficits finance themselves?” (National Bureau of Economic Research, Working Paper 31185, April 2023), George-Marios Angeletos, Chen Lian, and Christian K. Wolf argue that, under specific circumstances, government deficits can indirectly pay for themselves. The crux of the argument is that, over time, government deficits indirectly increase government revenue and indirectly erode the real value of government debt.

Theoretically, when a government issues stimulus checks, the money trickles down throughout the rest of the economy and spurs economic activity. With more economic activity comes more tax revenue. According to the authors, the extra tax revenue can then be used to pay off the debt incurred from the initial deficit. One tradeoff of issuing stimulus checks is the possibility of rising inflation.

If all households immediately spend a large portion of their stimulus checks, the supply of goods and services in the economy may not be able to keep up with consumer demand. That is, the level of “demand” might not be able to keep up with “supply.” If supply cannot meet demand, prices will rise; that is, inflation will increase. Although inflation is often perceived as negative, in this case, it may have an unintended benefit.

A deficit is created when, in a given fiscal year, a government spends more money than it raises. To finance the spending that a government’s revenue cannot cover, the government will issue bonds (essentially an “IOU”). Bonds are like loans; at a specified point in the future, the amount of the original loan must be repaid. In addition, the government must pay interest on its bonds. Even if prices rise, the initial amount that needs to be repaid does not change. So, if the inflation rate becomes bigger than the interest rate on government loans, the real (inflation-adjusted) value of government debt decreases, making debt easier to pay off.

For stimulus checks to raise tax revenue and erode the value of government debt, the authors lay out a series of specific conditions:

· The country’s central bank (the Federal Reserve for instance) cannot substantially raise interest rates to calm the inflation created by the boom.

· People must spend the bulk of their stimulus checks and do so quickly.

· If, in the future, the government raises taxes to pay off the debt incurred from the initial deficit, the farther in the future the tax hike is, the more the original deficit becomes self-financing.

Despite the positive implications for stimulus spending, Angeletos, Lian, and Wolf note that their model has an important limitation. The model assumes a large economy that is relatively closed to international finance and trade. In a more open economy, some of the stimulus payments could be spent on imports or invested overseas, reducing the size and longevity of the domestic economic boom. A smaller boom means less tax revenue and lower inflation, giving the government less money to pay off the deficit and less domestic inflation to erode the debt’s value.