No to Wasteful Coronavirus Stimulus, Yes to Social Insurance
Policymakers and central banks can cushion the crisis's blow, but they must act wisely.
It all began in December of last year when a hospital in Wuhan, the most populous city in Central China, reported a number of pneumonia cases of unknown origin. A few days later, on January 8, a new virus, which was later named by the World Health Organization as COVID-19 or just the coronavirus, was identified as the cause. When the newfound virus was discovered to be extremely contagious, Chinese authorities rushed to take measures aimed at curbing its spread.
At the time, nobody could have imagined that, only a few weeks later, the coronavirus would become the largest black swan since the Great Recession, causing thousands of deaths across six continents and triggering the most severe global economic crisis since 2008.
According to Deutsche Bank, the American economy is expected to contract by almost 13 percent on an annualized basis in the second quarter, the largest plunge in economic activity since World War II. Similarly, the Eurozone’s GDP will shrink at a 24 percent annual rate in Q2. Whereas in China, where the worst is (allegedly) already over, GDP fell at an annual rate of 30 percent in the first quarter of 2020.
Although the German bank forecasts a V-shaped type of recession (a large plunge followed by a quick and strong recovery), the seriousness of the threat has led monetary and fiscal authorities on both sides of the Atlantic to take measures in order to counter the impact of the crisis on the global economy.
The first central bank to take action was the Fed, which cut the policy rate target to between 0 and 0.25 percent. In addition to the rate cut, Chairman Powell announced that the Fed will buy Treasuries and mortgage-backed securities “in the amounts needed” (at least $700 billion), the creation of a credit facility to purchase up to $1 trillion in commercial paper from companies struggling to refinance their operations in the financial markets, and, for the first time in its history, the purchase of corporate bonds in the primary and secondary markets.
The European Central Bank on Wednesday expanded its disappointing initial stimulus package by announcing that it will purchase $800 billion in corporate and public debt. The Governing Council also stated that it will do “everything necessary within its mandate,” evoking Mario Draghi’s famous 2012 “whatever it takes” speech.
Governments have also stepped up and announced fiscal measures. Senate Republicans rolled out a $1 trillion stimulus package last Thursday, which includes direct payments to individuals under a certain income threshold, loans to small businesses and distressed industries, and financial support to the health care industry. In the Eurozone, the response to the crisis is coming from national governments. Spain, Italy, and Germany have taken the lead, putting forward aggressive fiscal packages to fight the economic consequences of the virus.
But will these measures suffice? Or put differently, can monetary and fiscal policy get us out of the worst crisis of the last decade? The answer to this question is a resounding no. When a negative supply shock hits the economy (e.g., floods, hurricanes, a surge in oil prices), total production falls and the economy contracts regardless of what the monetary and fiscal authorities do.
Yet the coronavirus crisis isn’t a typical supply shock. The pandemic is also affecting aggregate demand due to the lockdown measures imposed by governments and the uncertainty regarding when the crisis will come to an end. This is no doubt magnifying the impact of the pandemic on the economy. How can we get investment and consumption (the two major components of aggregate demand) back to normal? The only way is by defeating the pandemic as quickly as possible so that supply chains are restored, production increases, and demand for goods and services returns to pre-crisis levels. Does this mean there is no role for monetary and fiscal policy? Should policymakers stand still until this is over? Not at all.
Central banks and governments can help alleviate the impact in several ways. First, the Fed and the ECB should act as lenders of last resort and provide the necessary liquidity to corporates. In this sense, the Fed has already taken steps by setting up a short-term funding facility to lend to businesses directly. Second, policy-rate cuts and bond purchasing programs should be accompanied by a commitment to continue easing monetary policy as long as necessary (what economists call forward guidance), thereby sending a calming effect to financial markets, which have been severely hit by the pandemic.
Finally, a move from the current inflation-targeting regime to a nominal GDP-targeting regime, as proposed by the Mercatus Center’s David Beckworth, would make the commitment mentioned above more credible, especially when interest rates hit the zero lower bound (ZLB). Under such a monetary framework, the Federal Reserve would target the growth rate of nominal GDP (i.e., real GDP unadjusted for inflation), which would provide more inflation flexibility over the cycle and prevent the ZLB from limiting the capacity of central banks to foster economic growth.
For their part, governments should make use of fiscal policy, but wisely. It is not time for wasteful stimulus policies aimed at boosting aggregate demand, but for providing social insurance to those who need it. In this sense, the St. Louis Fed’s Bill Dupor has put forward a fiscal plan aimed at mitigating the negative effects of the coronavirus crisis on the most vulnerable segments of society.
His proposal, which, by the way, is substantially less costly than Republicans’ stimulus package, includes an increase in expansion unemployment insurance benefits, subsidies to expand the Continuation of Health Coverage (COBRA) program, cash transfers to individuals, fiscal support to state governments, and the abolition of penalty fees for withdrawing money from IRA accounts. All these measures would be temporary and would provide a safety net to those most likely to be affected by the crisis.
With few exceptions, world policymakers have been late to tackle the coronavirus crisis. Now it’s time to make up for past mistakes by doing what’s necessary to alleviate its impact on the economy. Will they?
Luis Pablo de la Horra holds a MSc in Finance. He’s currently doing a Master of Research in Business Economics, prerequisite to start a Ph.D. in the same field in 2018. He has been published by CapX, Speak Freely, and the Foundation for Economic Education, among others.