The Economic Consequences of Handouts

Newsom’s initiative to provide monetary assistance through relief checks is likely to boost overall demand, which could, in turn, exacerbate inflationary pressures.

From a socially conscious perspective, this move can be viewed positively. The governor's intention is to assist those who have been most adversely affected by rising prices. Essential items, such as food, housing, and energy, have seen significant price increases over the past year, while many people's incomes have not kept pace.

Individuals who are particularly struggling include those in lower-middle or lower-income brackets, as well as retirees on fixed incomes. Their financial situations have deteriorated due to inflation outpacing their earnings, leading to a decline in their quality of life. Although the proposed amount is not substantial, it could provide some relief.

California is currently experiencing high tax revenues, and Newsom believes that the projected $17 billion cost of this program can be accommodated within the state’s record $97 billion budget surplus. Thus, from a social standpoint, the relief checks appear to be a sound initiative.

Economic Implications of Increased Demand

However, when viewed from an economic standpoint, this plan is quite problematic and could indeed worsen inflation. The issuance of these checks is poised to escalate aggregate demand at a time when inflation is already being driven primarily by excessive demand. The Federal Reserve has been raising interest rates to curtail demand and manage inflation levels.

Today's inflation is also partially attributed to supply-related issues stemming from rising energy prices, increased labor costs, and some ongoing supply chain disruptions. Despite these challenges, the economy is currently producing at a level above pre-pandemic rates, which indicates that supply issues are only marginally influencing inflation at this time.

With businesses facing higher production costs, there is an inevitable upward pressure on prices. However, the primary driver of current inflation is excess demand, a situation largely fueled by federal fiscal and monetary policies enacted over the last couple of years.

In 2020 and 2021, the federal government spent approximately $6 trillion more than it generated in tax revenues. This year, the monthly deficit stands at around $130 billion, leading to a surge in overall demand and consequently high inflation rates.

Additionally, the remarkably lax monetary policy of 2021, which maintained near-zero interest rates and significantly boosted the money supply, further heightened aggregate demand, contributing to the 8.6% inflation rate that consumers are grappling with today.

While the Biden administration claims to have significantly curtailed the deficit this year—from $3.1 trillion to about $1.4 trillion—this figure remains the third highest in history. The lack of stimulus packages amid rampant inflation suggests that the deficit could be reduced even further.

Biden asserts that the reduction of the deficit will lead to a decrease in aggregate demand, which he argues is a step toward mitigating inflation.

Simultaneously, the Federal Reserve is actively working to lower aggregate demand as a means to tackle inflation. It ceased its $120 billion monthly bond-buying program in March and has begun decreasing its balance sheet by selling recently acquired bonds, which will slow the growth of the money supply.

Moreover, the Fed has hiked interest rates by 25 basis points in March, 50 basis points in April, and 75 basis points in June, culminating in a total increase of 1.5 percentage points from near-zero levels. It is anticipated that the Fed will implement another 75 basis point increase in July. These measures aim to diminish aggregate demand and eventually alleviate inflation.

In conclusion, while Newsom’s plan to distribute free money to residents through relief checks is intended to support those in need, it is likely to amplify demand and worsen inflation. Although the lowest income groups and those on fixed incomes may be the most affected by demand reduction strategies, simply giving away money will ultimately contribute to inflationary pressures. Thus, overall, this initiative appears to be a misguided approach.