Policymakers, please stop counting!
March 19, 2020
It’s a new competition. Governments and central banks keep announcing increasingly large targets for their spending and lending. Each announcement dwarfs the previous one, sometimes made just a few days before. No only does this ramping up betray their ignorance of the situation, but it also reveals a fundamental weakness in their thinking.
The best example is provided, of course, by President Trump, but other leaders should not scoff. After famously predicting that all will be well soon, he promised a $2.5 billion package (0.01% of GDP). Congress then voted for a package of about $100 billion (0.5% of GDP). Not one to be seen weak, Trump is now talking about 1 trillion (5.2 % of GDP). Watch out for the next announcement. More or less the same show is happening everywhere daily.
Of course, we are stepping into uncharted territory. Every day, we find out more about the epidemic and its economic consequences. The process will continue, over and over again. The question for policymakers is how to react to daily news. What we have seen recently cannot be the answer, they need to look beyond the headlines.
Policymaking must factor in an unusually huge degree of uncertainty. It is by now reasonably well understood that the policy response is to target the millions of hardships that affect firms and people. One purpose is to simply alleviate misery. Another is to prepare the resumption of normal activity once the epidemic is over, hopefully paving the way for a boom that will make up for the deep depression under way. Both objectives require that people are not left without incomes and that firms are not pushed into liquidation. This is well understood, but the challenge is that each firm and each household is a special case. Sending checks around as Trump (again) plans to spend his trillion is far too blunt, expensive and inefficient. A more granular approach is in order, but it is complex and time consuming, while doable; ideas keep popping up.
Since time immemorial, governments have accepted that budgets must be carefully planned and evaluated, even if the commitments are sometimes forgotten as soon as they are made. Providing detailed quantitative budgets is not just good practice, it is required, and it may explain why we see these rafts of announcements. But the present situation simply makes it impossible to plan. The question is whether policymakers should announce policies without numbers.
When numbers are promptly revealed to be fanciful, it may be time to temporarily set old principles aside. Policymakers, governments and central banks, ought to rigorously focus on the details of their policies. They also have to be ready to adjust them when we know more. At the same time, they should stop counting uselessly. It will cost whatever it will, period. And we will know soon enough the amount of the final bill, which is bound to be humongous.
This, in turn, means that governments need to plan right away what they will do when they figure out the total cost. If things are done correctly, the likely post-epidemic scenario is a fast recovery, quite possibly a boom as people buy what they could not buy during the crisisand firms work over time to satisfy the resurgent demand. Macroeconomic management policies are likely to be unnecessary. This will be when governments must make up for excess spending. Making sure that this happens is not easy. There will be millions of bad reasons to postpone the adjustment.
An important benefit of thinking ahead of the retrenchment is that it also tells us what do now in the midst of the epidemic. Governments must help out, but this can be achieved through either loans or transfers. The choice depends on the type of action, considered each one individually. It also matters for the eventual retrenchment. Loans will be reimbursed, but how soon and how fast? This must be specified ex ante. Transfers will be gone forever, but can be recaptured when the boom generates unusual gains and profits. This must be done fast because the boom will not last very long. Advance planning is essential.
As for central banks, their first task is to ensure that the economic crisis does not morph into a financial crisis. They also want the financial institutions to lend abundantly to households and firms that struggle through the turmoil, and to governments that will need to borrow gigantic amounts to fund their policies. They are clearly focused on both objectives. They provide ultra-abundant cash to the financial markets in order to avoid the kind of freeze that occurred in 2008, when transactions stopped because traders were not sure that their counterpart could pay what they bought, or actually be bankrupt. Several central banks have sharply reduced the interest rate, which makes borrowing more affordable.
Central banks too have announced how much money they intended to provide to the financial markets. Like governments, in short order many central banks have been led to announce higher numbers. Announcing the size of these interventions is the now-standard quantitative easing approach adopted during the financial crisis, but is it appropriate in the present case?
We are not seeing a financial crisis, at least not yet. Stock prices have fallen far and fast, and central banks often believe that putting a huge pile of money on the table can stabilize the financial markets. However, stock prices were widely seen as too high before the onset of the epidemic. Back then indeed, a familiar concern was about an eventual correction. The correction is under way now, a silver lining of the epidemic. It should be allowed to run its course. It may overshoot, but so what? Over the last decade, shareholders have made fortunes, now they stand to give back some of their gains. New gains will return after the panic. This is not a financial crisis and the central banks should not attempt to shore up asset prices.
Why do they announce numbers, then? Maybe it is hubris. They want to be seen as even more powerful than governments, but it is a bit too childish to be plausible. More likely, they simply want that their calls to financial institutions, that credit should be flowing, be taken seriously. They can do better. The unique characteristic of central banks is that they have bottomless pockets. This allows them to announce potentially infinite interventions. Announcing numbers deprive them from their more potent tool. Barely announcing that they would provide whatever it takes would be a more powerful signal and allow them to avoid the painful process of rapid changes in their announcements since the required amounts are unknown ex ante.