The monetary stimulus of the coronavirus must be accompanied by a psychological stimulus for consumers
Soon-to-be-signed stimulus bill offers consumers 500 billion dollars in cash to use as they please. Normally, cash would be a safe way to stimulate the economy, as consumers would be inclined to spend most of it on goods and services.
But in our coronavirus economy, many consumers may not be pressured to spend this government windfall. The monetary stimulus must be accompanied by a consumer psychological stimulus (CPS) to motivate consumers to spend the money and thus grow the economy.
This need for CPS is essential, since total consumption expenditure on goods and services represents 70% of our gross national product. Without it, many will continue to sit on their sofas, making a recession more likely.
According to Congress and the Treasury Department, $500 billion in cash would be returned to consumers upon signing the bill, as they recognize the urgent need to revive the economy. The bill would also provide approximately $1 trillion in loans small and large companies to continue their activities.
Cash incentives for consumers would vary based on income and family size. As of this writing, people earning $75,000 or less would receive $1,200 and a family of four would receive up to $3,000. In total, people would have an extra half trillion dollars to pump into the economy.
This is a significant sum, although it may not be enough to avoid a recession, especially given the rapidly increasing number of unemployed. And without CPS to motivate consumers to spend money, it would have a lower impact.
In the pre-coronavirus era, consumers were spending the $500 billion on goods and services in line with their tendency to spend extra money. This is called the marginal propensity to consume (MPC).
In the United States, the MPC is very high, especially compared to other countries, because Americans prefer to spend most of their extra income rather than saving it. MBMs vary by income level and employment status. Low-income consumers and the millions of people who have lost or are about to lose their jobs would spend most, if not all, of the money they receive just to survive. Money spent creates cycles of additional spending, known as the multiplier effect (ME).
The higher the MPC, the greater the ME. For example, when the MPC is 90%, the ME is 10, which means that the $500 billion would increase GDP by ten times that amount, for a total of $10 trillion. When MPC is 80%, ME is 5 and total GDP is $5 trillion. These figures reflect impressive increases in GDP in normal times, before the coronavirus.
But there is nothing normal about the behavior of the US economy and consumers in the face of a pandemic.
The coronavirus has hit consumers with large doses of fear, uncertainty and bewilderment and has frozen their behavior. As a result, consumers would be inclined to spend much less of the money provided by the government.
Also, even if they wanted to spend all that money, they won’t have many ways to do so, as most malls, restaurants, cafes, bars, theaters and cinemas are unavailable until further notice. . Assuming the corona-time MPC drops to 20%, ME becomes 1.25, resulting in a GDP increase of only $625 billion, a far cry from the full GDP increase when the MPC is 90% or 80%.
Bottom line: The GDP impact of the $500 billion given to consumers to spend will be far less than it is in normal times. How much less is anyone guessing. But the longer the fear and uncertainty last, and the longer the voluntary and semi-compulsory isolation continues, the less consumers will spend and the weaker the effects of available money on reviving the economy will be.
By using the CPS, Americans can be motivated to spend the available money and therefore grow the economy, i.e. continue to spend the money as in the pre-coronavirus era. Such motivation is akin to boosting people’s morale in times of war, like what Winston Churchill provided in his speeches to his fellow Britons during World War II.
US leadership is needed to develop and use CPS to engage consumers. Such leadership must begin by recognizing the devastating effects of the coronavirus and the gravity of the situation. No denial, no excuses, no pirouette. Leadership must then understand and accept people’s anger and frustration and be honest and empathetic. It must instill hope and optimism for a better future — a future that can be achieved by spending the money given to them, and thus improving everyone’s economic situation.
Such leadership must be knowledgeable and trusted by consumers to be effective. Now is not the time to blame anyone, any country or any party. Everyone is in the same boat, which could sink at any time.
So far, leaders have shown determination in designing a major monetary stimulus package. It must now rise to the occasion and provide a psychological stimulus to consumers to stimulate consumer spending to revive the economy. Can he? Hope is eternal.
Avraham Shama is the former dean of the University of Texas College of Business, The Pan-American. His book, “Dawn of The Cyberwars”, is forthcoming.