How Does the Coronavirus Changed Everything About Economic Policy?
The coronavirus crisis has turned into the biggest threat to the global economy at least since 2008. The big difference this time around is that a surprising consensus has emerged about what to do about it. Indeed, the specific characteristics of the COVID-19 outbreak give it the power to change economic policy forever.
This week, even the previously cautious European Central Bank U-turned, launching a €750 billion ($809 billion) stimulus program that includes the bold possibility of backstopping the eurozone's weakest governments. Meanwhile, the Federal Reserve has deployed all the tools developed during the liquidity crunch 12 years ago—including facilities to support banks and companies and currency swaps with other central banks.
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Crucially, this comes amid a wave of spending pledges by governments—the most significant shift in economic policy since the 1970s, when the fiscal stimulus was abandoned as a primary tool to stabilise employment. According to UBS economist Arend Kapteyn, monetary expansion globally will amount to about 2% of gross domestic product this year, versus 1.7% in 2009.
The coronavirus pandemic has dramatically disrupted the everyday social and economic patterns of societies around the world. Economists have focused on its economic impact and on what central banks and governments should do in response to a significant simultaneous disruption of both supply and demand. There is consensus that governments will have to support businesses and workers who are losing income—or risk dangerous knock-on effects on banks and the real economy—and find a way to finance these expenditures. There is also an urgent need to ramp up the production of essential commodities such as ventilators, gloves, and masks; to provide hospital beds, and to ensure that required personnel can themselves turn up for work. Despite the disruption to supply chains and restrictions on the population, essential goods and basic services must be provided, firms must be kept from going bankrupt, and employment and incomes must be maintained.
These circumstances raise fundamental questions about the role of the market, and the public sector is doing what is needed on the required scale and with sufficient speed. Some economic thinkers are rightly attacking these problems with urgency. It is almost sure that 2020 will be a recession year in every advanced economy. Most affected countries have by now adopted strict lockdown measures. The economic statistics already coming in are abysmal, from unemployment claims to sales in the hospitality sector. It is almost impossible for most people to work or spend as much as they used to. A tree does not bloom in frost, and a frozen economy does not produce income.
Understandably, the first economic policy response was: do something, do it big and do it fast. The IMF lists sizeable emergency policies for more than a hundred countries, almost all adopted in the past few weeks. The first priority of these policies should be to support the health sector, quickly increasing the capacity of beds, staff and ventilators, mobilising the production of the valuable equipment through tax breaks, public purchases or direct government control, and spurring innovation in treatments and vaccines.
Beyond this immediate priority, there are three goals of economic policy now: make the impact of the frost on people's lifeless hard, preserve the economy's productive capacity for when we can unfreeze the economy, and get ready to raise the heat quickly. For each of them, there are different options, each with its virtues and its flaws. Countries have taken different paths in trading these off, often with little discussion on which is best.
To preserve wellbeing, facing a disaster that affects everyone, governments must provide social insurance to help the most vulnerable make it through. A decision facing policymakers could be to either use existing social insurance mechanisms or to give people cash transfers. Most European countries have done the former, expanding unemployment benefits and welfare payments while relaxing eligibility criteria. In the United States, where the safety net is weaker and has more trouble in reaching people, the government will be sending checks directly over the coming month. Cash transfers are not targeted to reach only those who need them, so they become costly, while too-generous unemployment benefits encourage more layoffs and quitting than required.
Another trade-off is whether to make support conditional on someone's current income, knowing that checking who qualifies takes time and creates bureaucratic hurdles so that the payments will be slower. Going further than any other country, the U.K. government is giving the self-employed 80% of their past profits as a cash grant, no matter how their business is doing right now.
The second goal is to have the economy ready to go back to work with a minimal shortfall in productivity when the lockdown period loosens. The fear is that companies that cannot make payments during the freeze will close their doors for good. Afterwards, it will take a long time for the right business to emerge, bringing together the right people to sell the right product in the right market. Some workers who are laid off now will later have trouble finding the same job that suits them and pays well. This re-matching of markets, companies and workers often makes recessions prolonged and painful. It is better to stop businesses from failing in the first place if the lockdown is going to be short-lived.
COVID-19—commonly known as the coronavirus—is already rippling through the U.S. economy and impacting workers. To provide policymakers and the public with guidance on steps we can take to mitigate widespread economic shock, and the Economic Policy Institute put together this toolkit with research-based analysis to cut through the noise.
This conversation took place during the Spring 2020 conference on the Brookings Papers on Economic Activity. Participants included Daniel Lewis of the Federal Reserve Bank of New York, Jan Hatzius from Goldman Sachs, and Lucrezia Reichlin of the London Business School discussing the economic outlook in the face of COVID-19. Robert Barro of Harvard University and François Velde of the Federal Reserve Bank of Chicago explained lessons learned from the Spanish Flu, and Jason Furman and Jeremy Stein, both from Harvard University, discussed potential policy responses. Brookings Nonresident Senior Fellow and Harvard University, Professor of Economics James Stock, moderated the conversation.
Obviously, this is a time of great economic turmoil, and there is enough to discuss that we could spend the entire afternoon on it, but instead of doing so, we're going to spend the next 40 minutes on it. So the first section with Daniel Lewis, Jan Hatzius, and Lucrezia Reichlin, is about the economic outlook, first in the United States, then in Europe. Daniel, you've got a couple of minutes. So in the face of COVID-19, we need signals of real activity at a higher frequency than our familiar monthly and quarterly aggregates. By the time we see the March data, it's hard to know what the state of the economy will be. So to answer this demand, we [constructed] a weekly index of real economic activity using higher-frequency data. So, broadly speaking, you can see a few things in the high-frequency data, and Jan will go into much more detail on specific sectors later.
The COVID-19 pandemic represents a significant shock to the global and European economy. Most European countries need to take bold quarantine and lockdown measures, as has been done in Italy, to prevent an explosion of the epidemic which would lead to many deaths and the collapse of healthcare systems. The economic consequences of such measures are major and are felt through both supply and demand-side channels. A coordinated and bold response by authorities is necessary.
- Ample national funds need to be provided to domestic health services.
- Targeted measures to support individuals (such as the self-employed), companies and the local communities most affected should be put in place or reinforced.
- Broad macroeconomic insurance needs to be provided because targeted measures will not cover the many second-round effects of the shock. To alleviate financial and cash-flow constraints, and to provide incentives to preserve employment, we recommend all E.U. member states agree to halve companies' social security contributions for three months or cut the payroll tax. Such measures could amount to support of some 2.5 per cent of GDP and would be funded by increased national deficits.
- The European Central Bank should provide abundant liquidity, increase swap lines to ensure sufficient dollar liquidity and improve its sovereign-bond purchase programme to prevent distress in sovereign bond markets.
- 'Whatever it takes' needs to be the motto to preserve lives and reduce the impact on the economy of the epidemic.
The rapid and global spread of the novel coronavirus (Dong et al. 2020) within just a few weeks is also infecting the global economy. Efforts to contain and mitigate the spread of the virus in order to reduce the loss of human lives have ultimate priority. Nevertheless, policymakers need to act quickly to address the mounting negative economic fallout from this crisis. To alleviate the negative medium- to long-term economic consequences, timely understanding of the effects on the consumer demand side of the economy is critical to initiate the appropriate responses to stabilise the economy. A significant worry is that a rise in consumers' income and employment risk weakens their economic stability and their economic sentiment, fuelling a long-term economic downturn through an expectation-driven downward demand shock.
In a new paper (Fetzer et al. 2020), we document a rapid increase in economic anxiety during and after the initial global spreading of the novel coronavirus, inferred through daily Google search activity and individual survey data (available at covid19-survey.org/). Further, we shed light on how perceptions of the coronavirus shape economic anxiety and study the role of information and the underlying psychological mechanisms.
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Governments and central banks around the world have unleashed unprecedented fiscal and monetary stimulus and other support for economies floored by the coronavirus pandemic.
The G20 said on March 26 it would inject more than $5 trillion into the global economy to limit job and income losses and "do whatever it takes" to tackle the pandemic.
A natural question for governments and decision-makers across the globe is how the economic fallout from the current crisis can be contained. The media may be playing an essential role in shaping how people perceive the underlying risks. Through an experiment embedded in our survey, we randomly exposed a subset of the respondents to information comparing the estimated mortality of the coronavirus with that of the regular seasonal Flu. Another subset of people was given a comparison of the mortality estimates with that of SARS.
We find that comparing the mortality of the coronavirus with that of the flu increases reported economic worries. This highlights that the way the press conveys information about the coronavirus may matter a lot in shaping the extent of financial anxieties. Given the significant heterogeneity in beliefs about critical characteristics of the coronavirus, our findings suggest that information and public education may play a central role in achieving successful containment and managing the negative economic impact of increased economic anxiety.
The Federal Reserve cut interest rates by a total of 150 basis points in two emergency meetings on March 3 (50 basis points) and March 15 (100 bps), taking the federal funds rate to 0-0.25%, along with $700 billion in asset purchases, or quantitative easing (Q.E.).
It also cut the discount window rate by 150 basis points. The Fed followed on March 23 with unlimited and open-ended Q.E., planned purchases of corporate, municipal government bonds.
Trillions of dollars in repurchase agreements, flooding the markets with cash; swap lines with other major central banks to provide dollar funding; program to support money market funds; various easing of bank capital buffers; funding backstop for businesses to offer bridging loans of up to four years; funding to help credit flow in asset-backed securities markets; also plans to extend credit to small- and medium-sized businesses.
The U.S. House of Representatives passed a $2.2 trillion aid package - the largest in history - on March 27 including a $500 billion fund to help hard-hit industries and a comparable amount for direct payments of up to $3,000 apiece to millions of U.S. families.
The European Central Bank on March 12 added 120 billion euros to its existing asset-purchase program of 20 billion a month. On March 19, the ECB said another 750 billion euros in Q.E., taking the total to about 1.1 trillion euros this year, and said Greece to the portfolio of bonds it would purchase. On March 26, it eliminated a cap on how many bonds it can buy from any single eurozone country.
The ECB cut the interest rate on its Targeted Long-Term Refinancing Operations (TLTROs), cheap loans to banks, by 25 basis points to -0.75% on March 12. It provided additional LTROs to bridge bank funding through to June and relaxed capital rules.
Suspension of limits on E.U. government borrowing; considering allowing precautionary credit line worth 2% of national GDP from ESM bailout fund.
Agreed package worth up to 750 billion euros on March 23; 100 billion euros for an economic stability fund that can take direct equity stakes in companies; 100 billion euros in credit to public-sector development bank KfW for loans to struggling businesses; stability fund will offer 400 billion euros in loan guarantees to secure corporate debt at risk of default.
45 billion euros of crisis measures on March 17 to help companies and workers; guaranteed up to 300 billion euros of corporate borrowing from commercial banks on March 16.
Emergency decree worth 25 billion euros on March 16, suspending loan and mortgage repayments for companies and families and increasing funds to help firms pay workers temporarily laid off.
A 200 billion euro package on March 17; half in state-backed credit guarantees for companies and the rest including loans and aid for vulnerable people. The government approved on March 31 a 700 million-euro aid package, including a measure to suspend evictions of vulnerable households for six months after the state of emergency, is lifted.
The Bank of England cut interest rates in two emergency meetings on March 11 (50 bps) and March 19 (15 bps), taking the price to a record low of 0.10%; announced 200 billion pounds of bond purchases.
The BoE introduced a new programme for cheap credit and reduced a capital buffer to help banks lend. A BoE corporate financing facility will buy commercial paper with a maturity of up to 12 months from businesses that had a pre-crisis investment-grade credit rating or similar.
A 30 billion pound stimulus plan on March 11; 330 billion pounds in loan guarantees to businesses; offered to pay 80% of wage bills if staff put on leave, up to a maximum of 2,500 pounds a month. Companies also allowed to hold on to 30 billion pounds in VAT temporarily.
The Bank of Canada cut rates in three emergency meetings on March 4 (50bps), March 13 (50 bps) and March 27 (50 bps), taking the overnight interest rate to 0.25%. The Bank also said on March 27 it would buy Government of Canada securities in the secondary market. It will begin with purchases of C$5 billion per week, across the yield curve.
Eligible collateral for term repo operations expanded; C$50 billion insured mortgage purchase program; C$10 billion credit support program for businesses. Canadian Mortgage and Housing Corp on March 26 bolstered the protected mortgage purchase program to C$150 billion from previously announced C$50 billion.
Ottawa will cover up to 75% of the wages of people working for small and medium enterprises; C$55 billion in tax deferrals for businesses and families; C$27 billion aid package for workers and low-income households.
The Bank of Japan eased monetary policy by ramping up purchases of exchange-traded funds (ETFs) and other risky assets, including corporate bonds. Also creating a new loan programme to extend one-year, zero-rate loans to financial institutions.
Government working on a stimulus package that could be worth 10% of economic output.
The government announced 430.8 billion yen of extra spending, much aimed at supporting small and medium-sized businesses. It will also fund upgrades to medical facilities, and subsidise working parents forced to go on leave because of school closures.
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The People's Bank of China (PBOC) on March 30 lowered the 7-day reverse repo rate to 2.20% from 2.40%, the most significant cut in nearly five years. The PBOC cut its one-year Loan Prime Rate by ten basis points to 4.05% on Feb 20, after various liquidity injections and additional policy easing earlier in the year.
The PBOC cut the amount of cash that banks must hold as reserves for the second time this year on March 13, releasing 550 billion yuan.
China offered more available funding for small- and medium-sized businesses, increasing yuan re-lending and re-discount quotas by 500 billion yuan (Feb 25); China also increased policy banks' loan quota by 350 billion yuan to make loans targeting these businesses.
China is set to unleash trillions of yuan of economic stimulus. It aims to spur infrastructure investment, backed by as much as 2.8 trillion yuan of local government individual bonds, according to sources on March 19. The national budget deficit ratio could rise to record levels, sources added.
The ruling Communist Party's Politburo said on March 27 it would step up macroeconomic policy changes and pursue the more proactive fiscal policy. It called for expanding the budget deficit, issuing more local and national bonds, guiding interest rates lower, delaying loan repayments, reducing supply-chain bottlenecks and boosting consumption.
Earlier in the year, Beijing introduced various small measures and fiscal expenditure such as tax breaks, reduced power charges and fee reductions.
The Reserve Bank of India slashed its benchmark repo rate by 75 basis points to 4.40% on March 27.
Federal government announced on March 26 a 1.7 trillion rupee stimulus plan providing direct cash transfers and food security measures.
Bank of Korea cut interest rates by 50 basis points to 0.75% on March 16.
The government will make emergency cash payments to all but the wealthiest families, totalling 9.1 trillion won, drawing up a second supplementary budget in April. Initial extra budget worth 11.7 trillion won; 50 trillion won in emergency financing for small businesses; key capital flow rules temporarily further loosened to encourage local financial institutions to supply more dollars.
Bank Indonesia cut its 7-day reverse repurchase rate by 25 basis points to 4.50% on March 19.
Jakarta announced an additional $24.9 billion in spending on March 31, including a three-point reduction in the corporate tax rate to 22%. Other measures were expanding social welfare to benefit up to 10 million households, food assistance and electricity tariff discounts and waivers.
The Reserve Bank of Australia cut rates in two steps (25 bps on March 3, 25 bps on March 19), taking the cash rate to 0.25%; introduced the first use of quantitative easing, setting a target of around 0.25% for bond yields.
A$90 billion funding facility to banks at a fixed rate of 0.25%; A$15 billion purchase program of residential mortgage-backed and other asset-backed securities; A$715 million support program for airlines.
A$66.1 billion in assistance for companies and additional welfare payments; A$17.6 billion in subsidies for apprentices, small businesses, pensioners and others; A$130 billion to subsidise wages of an estimated 6 million people.
Central Bank of Brazil cut interest rates by 50 basis points to 3.75% and eased capital requirements for financial institutions.
1.2 trillion reais central bank program to inject liquidity through purchases of bank loan portfolios; new rules allowing banks to offer firms and households increased loans and better terms; primary bank intervention in F.X. Markets and repurchases of dollar-denominated sovereign bonds.
150 billion reais budget boost to support most vulnerable population and jobs; presidential decree declaring national emergency allowing the government to waive financial targets and free up budget resources.
South African Reserve Bank (SARB) cut its primary lending rate by 100 basis points to 5.25% on March 19.
The SARB announced on March 25 a programme to buy bonds on the secondary market.
Governments and central banks globally have been engaged in an initial round of measures to blunt the anticipated economic impact of the spread of the virus. The International Monetary Fund (IMF), World Bank, and other international bodies are making available their own tools, such as the IMF's Rapid Financing Instrument and Rapid Credit Facility for countries with balance of payment problems. Some initial global coordination on economic policy is also starting through the Group of Seven (G7).
Equity markets continue to produce single-day swings that are historic by any measure. A key reason for this is that the public health objective of "flattening the curve" to ensure healthcare systems are not overwhelmed implies an extended period of time in which social distancing is desirable. The full paralysis of significant parts of the economy may well be with us for months as a result.
While many economic forecasts now predict a recession globally still this year, the uncertainty around this consensus is significantly higher than it would be in regular times. In addition to the uncertain duration of the slowdown of economic activity, downside risks that make it hard for investors to call the bottom of the stock market include a prolonged depression with mass unemployment, a financial crisis is emanating from massive corporate bankruptcies that cripple the banking system, and runaway inflation due to very loose monetary policy. An upside case to consider is a faster-than-anticipated development of a treatment drug and vaccine that would bring increased visibility to the ultimate path of the virus and radically improve clarity on the economic environment.
Central banks are deploying several tools to deal with these circumstances. Many have lowered their key interest rates to historic lows. However, the necessary public health policy response to the pandemic very much diminishes the impact of low-interest rates as consumers are less likely and unable to spend more. Central banks can also intervene in funding markets that are frozen or otherwise not functioning as standard, as the Federal Reserve (Fed) in the United States did on March 17 when it ensured corporations continued to have access to short term credit.
The world's major central banks are also making more aggressive use of discount windows and other forms of direct and indirect credit provision to the financial and real sectors of the economy, such as the European Central Bank's (ECB) changes to its longer-term refinancing operations program in order to support bank lending to small and medium enterprises. Most large central banks have resumed or expanded asset purchase programs, including $700 billion of U.S. Treasuries and mortgage-backed securities by the Fed and $135 billion of corporate and government bonds by the ECB. Finally, the Federal Reserve over the weekend of March 15 and 16 took steps to shore up global dollar liquidity through existing swap lines with the world's other major central banks.
Efforts announced or in advanced drafting by significant governments such as Germany, the U.K., the United States, and others focus on providing credit to the business sector to shore up companies of all sizes through the period of disruption. U.S. examples include the proposed $50 billion secured facilities for the airline industry and $150 billion for other affected business sectors. Similarly, the German State Bank KfW has been authorised to lend over $600 billion, and the U.K. has announced a $400 billion program of state-backed lending. Most other affected advanced economies, including Spain, Japan, France, Italy, and Canada, have announced similar plans. When evaluated in relation to the size of the economy, the (proposed) policy responses in the United States, Spain, Germany, and the U.K. already approach or exceed the efforts mounted in the Global Financial Crisis of 2007-08 and the subsequent European debt crises. In particular, the $1 trillion that the United States is proposing to spend initially is near-identical proportionally to the size of the Troubled Asset Relief Program (TARP) in 2008.
Discussions in the European Union about deploying the European Stability Mechanism (ESM, which has more than $430 billion of capacity) are ongoing. The ESM was created by and for the members of the euro area, so E.U. member states not using the euro would not benefit from any use of the ESM.
Finally, urgent measures are being proposed and implemented at the consumer level. U.S. policymakers are offering direct payments to taxpayers on a sliding scale. In Italy, the U.K., and elsewhere, tax date filing delays, mortgage and loan repayment holidays, and statutory sick-pay have also formed part of the government's response.
Policymakers globally have, in different terms, signalled their commitment to take additional steps as needed. As markets digest the outbreak's progress and the measures announced, other country-specific programs and international efforts—for example through the Group of Twenty (G20)—are likely to become necessary in the weeks to come.