Who pays the price of a financial stimulus package?
Whenever the economy is in turmoil, central banks and governments announce financial stimulus packages, and all of us cheer for these packages just like kids would do for gift packages.
However, just like the gifts we buy for kids have a price, there is a price to be paid for the financial stimulus packages too. The way these financial gifts are packed makes it difficult for us to understand who ultimately is paying for it. In this article, I will share some of my thoughts on this.
Firstly, stimulus packages come in 2 broad forms — Fiscal stimulus packages and Monetary stimulus packages.
Fiscal stimulus packages are gifts coming from the Government, whereas, the monetary comes from the Central Bank.
Fiscal stimulus packages
Fiscal packages primarily come in the form of lower taxes or higher government spending. These gifts make news headlines like:
Government announces free food grain scheme for 80 crore Indian citizens
Donald Trump to send $1,000 to Americans to cope with COVID-19
Tax deducted at source (TDS) rates reduced by 25%
To understand who pays the price for all this, let us think of a country as a large multi-family co-operative housing society. The home-owners pay monthly maintenance charges to the society (just like citizens pay taxes to the country) and the society committee members are expected to use it for shared expenses like repairing the elevators, mending the cracks, or painting the building (just like government is expected to use taxpayers money for social welfare).
One fine day, the committee members of the society announce a stimulus package for the home-owners which goes like this — Homeowners need not pay any maintenance charges for the next 2 years and the society will provide free food for all home-owners and the society will also construct a new tennis court, a gym, and a garden, and will also paint the whole building, and for all this, the homeowners need not pay a penny.
The first question that should come to your mind is — where will the money for all this extravagance come from?
This can come from two sources:
- The society already has a lot of money lying in the bank account that had accumulated over the years through a collection of maintenance charges, or
- The society will borrow money from the bank
The first option seems unlikely, because if the society already had so much money then why have they been charging for maintenance all this while.
The second option seems more likely, and if that is the case, society will need a huge amount of money in the future to repay the debt, and where will that money come from?
It has to come from the home-owners, to be more precise, the future home-owners, some who haven’t even enjoyed the benefits of today’s extravagance.
It is safe to assume that any organization which is on a spending-spree today, will be on a collection-spree tomorrow.
The same is the case with countries too. The price of today’s fiscal stimulus will be paid by the country’s citizens in the future in the form of higher income tax, higher GST, higher stamp duty, and most importantly, higher inflation, which is nothing but a tax in disguise.
We will understand this inflation tax in more detail as we now discuss the second gift, the monetary stimulus package — the more deceptive of the two.
Monetary stimulus packages
Monetary stimulus packages come from the central bank of a country in the form of lowering interest rates (read money printing). These gifts make news headlines like:
The US Federal Reserve cuts rates to almost zero and launches a massive quantitative easing program
Reserve Bank of India (RBI) cuts interest rates to 9-year low
Home loans set to get cheaper as banks cut lending rates
When central banks cut interest rates, commercial banks and governments are able to borrow money from them at a low-interest rate, in some countries, this is almost zero.
But where does the central bank get the money to lend? They print. Yes, just like you and I print MS Word and Excel files, they print money, and there is no limit to the amount of money a central bank can print. Gold or any other assets have nothing to do with how much money a central bank can print. Central banks can keep on printing money and lend to commercial banks and governments.
Commercial banks then pass on this lower interest rate to individuals and corporate borrowers and this leads to higher consumption and business investments. Simultaneously, commercial banks also reduce the interest that savers earn on fixed deposits and savings accounts.
But one thing to note is — as more and more money gets printed, the value of money goes down, and prices of products go up — this is what we call inflation.
Inflation however is selective in hurting people. It won’t hurt you a lot if you are salaried, or running a business, or own an investment property. After all, with inflation, even salaries, profits, and rental income will go up.
But what about the retirees? They face a dual problem, interest on their savings and fixed deposits go down, and their expenses go up because of inflation.
Some countries in the past have faced hyper-inflation because of reckless money printing by central banks. In such a scenario, you just need a few months for your bank savings to get wiped off. (Yes, the safest investment can become the riskiest.)
Monetary stimulus packages are a very shrewd and deceptive way of taking money from conservative savers and retirees — and this is done not by taking their money directly, but printing more money, which they don’t get.
Nevertheless, economists have an argument in favor of central banks and monetary stimulus packages here. Remember, lowering interest rate is a way to incentivize businesses to borrow and invest which could potentially revive the economy, and disincentivize the conservative savers and retirees who are doing nothing for the economic recovery.
I personally don’t buy this argument totally. Yes, to some extent it’s true, but it’s a very harsh one.
To sum up, stimulus packages are not free lunches. We have to pay for it in the future in the form of higher taxes and inflation, and it is not something to blindly cheer for.
Thank you!