Newsom’s handouts: Economically Bad, Socially Not so Bad

Recently California Governor Gavin Newsom said he wants to give up to $1,050 to about 23 million Californians in the form of an “inflation relief check.” He said these payments will have income limits so the lower-income earners will receive the most. Is this a good idea?
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Newsom’s plan to give more free money to consumers in the form of relief checks will increase aggregate demand and worsen inflation.
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The answer is that it depends on your point of view.

From a socially responsible viewpoint, this is a good idea. Newsom’s purpose is to help those most negatively impacted by inflation. Necessities, like food, shelter and energy prices have skyrocketed in the last year, while their incomes haven’t nearly kept pace.

Those most hurt by inflation are those in the lower-middle or lower-income class, as well as people on fixed incomes, many of whom are retirees. Their incomes haven’t nearly kept up with inflation. As a result, they have seen a decline in their standard of living.

Those most vulnerable Americans need help. This amount is not large but will help.

California continues to see high tax revenue, and Gavin believes that the $17 billion cost of this program can easily be covered by the state’s record-setting $97 billion budget surplus. From a social standpoint, the relief check seems to be a good idea.

From an economic perspective, this idea is very bad and will indeed make inflation worse. That’s because these checks will increase aggregate demand at a time when most of the inflation is caused by excess demand. Indeed, the Federal Reserve is raising interest rates to reduce demand and bring inflation down.

Today’s inflation is partially caused by supply issues due to increased energy cost, increased labor costs and some supply chain issues. However, since the economy today is producing at a rate that is higher than before the pandemic, supply issues are having just a minor impact on the inflation rate.

Obviously, with business paying more to produce their output, upward pressure is put on the price. But most of today’s inflation is caused by excess demand. The excess demand is a result of the federal government’s fiscal and monetary policies over the past two years or so.

In 2020 and 2021, the federal government spent nearly $6 trillion more than it raised in tax revenue. This year, the government is spending about $130 billion more each month than is received in tax revenue. This deficit spending has caused total demand to skyrocket — leading to high inflation.

In addition, the shockingly irresponsible monetary policy in 2121 kept interest rates near zero and vastly increased the money supply. That also increased aggregate demand which further contributed to the 8.6% inflation that consumers are dealing with today.

The Biden administration likes to claim that it has significantly reduced the deficit this year. The deficit will fall from $3.1 trillion to about $1.4 trillion. While that is a large reduction, the deficit will still be the third highest in history. With runaway inflation and no stimulus packages being passed, the deficit should fall much more.

Yet Biden is saying that by reducing the deficit, aggregate demand will fall. Biden is saying he is doing what he can to reduce inflation.

Similarly, the Fed is trying to reduce aggregate demand to bring down the inflation rate. It stopped its $120 billion monthly bond-buying program in March of this year and has started to reduce its balance sheet by selling some of the bonds it recently purchased. This will reduce the rate of growth in the money supply.

In addition, the Fed increased interest rates by 25 basis points in March, 50 basis points in April and 75 basis points in June, for a total increase in the fed funds rate, which was hovering near zero, by 1.5 percentage points. It is likely the Fed will raise interest rates by another 75 points in July. These actions will reduce aggregate demand and eventually reduce inflation.

Newsom’s plan to give more free money to consumers in the form of relief checks will increase aggregate demand and worsen inflation. While it is true that the demand reduction actions mean that the lowest income earners and those on fixed incomes will be hurt the most, giving away free money will increase demand and worsen inflation.

Overall, this is a bad idea.

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