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A remake of 2010?

September 24, 2020

In 2009, in the wake of the subprime crisis, the G20 countries pledged to mobilize their fiscal and monetary policies to avoid a Great Depression. By 2010, they prematurely declared mission accomplished and left the central banks to complete the task. By the time the Covid pandemic hit, the central banks were still trying to blow enough wind in the sails to get inflation rates up to their professed targets. Faced with the pandemic outbreak, once again, the governments moved swiftly to soften the economic impacts of lockdowns, and it has worked. Mission is not accomplished, yet, and will not be accomplished until the economies have recovered in a post-vaccine world. And yet, the resolve of many governments already wanes much as central banks keep it up while begging governments to stay in the game.


Quite visibly, in spite of their rhetoric, central banks have run out of ammunitions. Scared consumers are saving. Will they dissave once the coronavirus is vanquished? It’s likely to depend on the economic situation that will prevail at that point in time. If, by then, unemployment has risen and many firms have gone belly up, a safe bet is that the celebrated pent-up consumption growth will give way to continuous precautionary saving. This will depress corporate investment. Growth will remain sluggish. The economic, social and political consequences of a long-lasting recession stand be rather appalling. This time, the pain suffered during the pandemic will make all these much worse, too worrisome to even contemplate. There must be a better way.


To borrow from central bank vocabulary, fiscal policies will need to be expansionary long enough to bring about a self-sustained recovery. When to worry about the public debt cannot be specified on calendar terms ahead of time, the criterion can only be the prevailing state of the economy. Governments have seen that debts can grow when needed, without triggering a financial Armageddon. Now is not the time to bring debts down, nor any time soon.


But it is possible to temporarily set aside the debt constraint only if the policies are well designed. They must narrowly focus on actions that directly aim at the recovery, that can be decided and implemented fast, and that have large multipliers effects. These policies must also clearly be temporary if only in order to reassure the markets that the deficits will be closed when the time has come. The policies enacted since the epidemic outbreak fit these requirements. The risk is that the requirements be forgotten in the next step.


Governments brave enough to consider adopting a countercyclical fiscal policy stance could well try to kill too many birds with one stone. In Europe, this is what is shaping up. Governments find it politically attractive to fight climate change. This is an indispensable long-run objective but it calls for slow-to-enact investments and for permanent action. Mixing up recovery and climate change could also be self-defeating. If the deficits cannot be closed down and debts keep rising dangerously, financial market turmoil could well force an abrupt cut in these investments, possibly for a long time.


What is to be done, then? Up until a Covid vaccine is widely available – hopefully in the second half of 2021 – the current measures to limit unemployment, support the unemployed and limit bankruptcies must remain in place, not matter how high are their costs. This is not about recovery but about disaster mitigation. At the same time, governments must design and gradually enact recovery policies.


When the pandemic recedes, hopefully for good, the exceptional measures will have to be discontinued, because of their costs. This could lead to a rapid rise of unemployment and bankruptcies. The purpose will no longer be to protect jobs but to protect people, nor to keep zombie firms alive but to provide surviving and new firms with reassured consumers. The focus should be on the demand side, not the supply side once social distancing measures are discontinued.


With health risks much reduced, consumers should be eager to dissave what they have accumulated, but that probably will not be enough. It will crucial to deal with the risk of being unemployed. Temporary incentives could be provided to firms so that they start re-hiring sooner than later. 


Tax cuts and subsidies, tilted toward the needy, could play a useful role, but they will have to temporary in order to eventually restore budget balances. However temporary tax cuts often lead to saving, not consumption. This effect is somewhat reduced with consumption taxes (in many countries, VAT).


For this reason, it is likely, that the most effective tool will be a temporary hike in public spending. Ruled out are entitlements of any sort, including public employment and long-lasting projects. Instead, governments could temporarily invest into one-off projects. Infrastructure comes to mind but compensation for structural reforms (making sure that those who stand to lose are adequately compensated) or one-off subsidies to enterprises that have been hit by the epidemic also belong to the toolbox (the British restaurant vouchers are a good example, unfortunately they came too early, probably contributing to the rise in the number of infections).


The message to governments is clear: forget deficits and keep spending but keep in mind that the debt will have to be brought down.

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