March 18, 2020 / 3:35 PM / 17 days ago

Breakingviews - Hadas: This is no ordinary anti-crisis stimulus

LONDON (Reuters Breakingviews) - Covid-19 is causing a global recession. Ever stricter restrictions on activity are pushing down gross domestic product throughout Europe and the United States, while economic activity will only slowly return to normal in China and South Korea. However, these macroeconomic numbers fail to capture the unusual nature of the current situation.

The Bank of America building is seen between London's HSBC headquarters and One Canada Square tower in the Canary Wharf financial centre, in London, Britain June 24, 2016.

Typically, a current decline in GDP is fairly easily reversed. Anti-recessionary government policies aim to do exactly that, by providing money to hire unemployed workers and inspiring the confidence required to undertake new investments. This time is different.

No amount of money printing, no interest rate cuts, no targeted incentives, can get planes flying, re-open schools and restaurants or renew demand for hotel rooms. The only thing that will restart economic activity is public health policy. Until medical professionals give their all-clear, economies will stay smaller than before the outbreak of the virus. But three other economically vital purposes are served by government measures, such as the United Kingdom’s promised loan guarantees of 15% of GDP, French President Emmanuel Macron’s expansion of benefits for the unemployed, or U.S. Treasury Secretary Steven Mnuchin’s cash handouts.

First, they support economic solidarity in a time of national crisis, by assuring that the goods and services which remain available are distributed fairly. Without carefully designed policies, the losses would be borne by the wrong people, those who cannot realistically hope to get new jobs for as long as restrictions on activity close off the path to national economic expansion.

Such an unequal division of unavoidable economic pain would unjustly add to already troubling economic inequality within countries. An expanding array of measures to support those on low incomes will counter that tendency. They work like universally distributed ration tickets, ensuring that the poor do not lose out too much to the rich.

Second, these programmes ensure that production in the economy stays as high as possible. Employed people are cutting back spending involuntarily, because they cannot go out or travel. Unless the involuntarily unemployed can continue shopping, there will be an unnecessary reduction in total demand, leading to unnecessary increases in unemployment.

Cash handouts are only one part of this effort. Governments are wisely trying to discourage consumption-killing thrift, a typical popular response to uncertainty. The authorities hope to instil confidence by promising to do whatever it takes to ensure that the shrunken available capacity is fully utilised.

Finally, higher government spending and policy initiatives help maintain the economy’s potential. Companies are more than merely financial and legal entities. They are repositories of shared expertise and trust. A wave of bankruptcies would break many of the business relationships and drain some of the pools of knowledge which are crucial to complex modern economies. By lowering the cost and increasing the availability of credit, policymakers can stave off this unnecessary disaster.

More than government money is involved. Regulatory changes are pushing banks towards forbearance, and outright bailouts are likely to maintain airlines and other especially troubled companies in running order. Some of these efforts have drawbacks. While the income supports for vulnerable workers promote social justice, the array of subsidies may sometimes seem to reward past excesses. In particular, they will help companies that have relied too much on debt or paid out too much of their earnings to shareholders. No wonder that some American politicians, including Senator Elizabeth Warren, want these programmes to include labour-friendly conditions.

Most economists are enthusiastic supporters of large anti-virus initiatives. They are unconcerned about the likely vast increase in government deficits. This is clearly a time for government activism rather than free market fundamentalism. Still, the maintenance of incomes without corresponding production will create a potential monetary problem, a surplus of money in the economy compared with the supply of things to buy with them. In traditional monetary theory, that imbalance tends push up prices.

An inflationary outbreak is unlikely now, because money that cannot be spent on unavailable things like restaurant meals and nice holidays is more likely to be saved than used to outbid other buyers for whatever is available. Things may be different later when bank accounts are full and the economy is booming. However, any undesirable inflationary momentum can be stopped fairly easily. For example, a one-time tax on savings made during the viral months or years would be a fair and effective way to drain money out of the economy.

In pre-Covid-19 days, that sort of levy was politically toxic. It would be a wealth tax that falls mainly on the middle class who could work from home during the pandemic. However, fair and effective government measures to help all citizens now could change the mood later. Solidarity is often built out of shared suffering.


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