Fighting the downturn - The Monday Briefing


The economic policy response to Covid-19 is starting to catch up with the escalating scale of the crisis. It is driving a cart and horses through conventional wisdom. The post-financial crisis shrinkage of government borrowing is over. Radical economic policies are on the agenda. Public spending and debt are set to soar. France is ready to nationalise at-risk businesses; Germany plans to take equity stakes. Money-printing by central banks to finance government spending, once a taboo associated with Weimar Germany and Zimbabwe, is no longer out of the question.

Declining liquidity and rising stress in financial markets last week testify to the urgent need for action. The value of riskier assets such as emerging-market government debt or ‘junk’ bonds plummeted. Such was the panic that even assets traditionally seen as safe havens, such as gold and US government bonds, came under pressure as cash and dollar-hungry investors sold positions.

The response has been on a huge scale. The Federal Reserve cut rates by an unprecedented one-percentage point and, along with the European Central Bank and Bank of England, has launched programmes of asset purchases. Central banks are massively scaling up the provision of loans to corporates. The Federal Reserve has offered new support to five major foreign central banks to support dollar liquidity.

Markets stabilised somewhat on Thursday in light of the measures from central banks. But we are at the start of a major economic downturn of uncertain duration. Despite all the measures that were announced last week, the US S&P 500 equity index fell by 4.3% last Friday, the largest decline since 2009.

Last week many governments announced measures to support businesses and household incomes. As with monetary policy, the scale of the prospective fiscal easing is significant. In the UK budget the government announced £12bn of extra spending, followed by another £20bn last Wednesday. On Friday the chancellor Rishi Sunak unveiled “a coronavirus job support scheme”, extra support for those on benefits and a deferral of VAT payments and income tax for the self-employed. There is no official estimate of the cost of these measures but it is quite possible that the extra public spending in the UK could exceed 2% of GDP in 2020–21.

The Financial Times reported over the weekend that, in a historic shift, the German government is planning to jettison its longstanding commitment to balancing the budget. A €150bn increase in public borrowing will be accompanied by state-backed loans for corporates and a plan for the government to take equity stakes in ailing companies.

Mitigating the shock to incomes and businesses and preserving the productive capacity of the economy are essential for a swift recovery. Above all, lost incomes need to be replaced. Welfare systems provide a safety net, but in the UK replacement income tends to be low, conditional and slow to arrive (Continental schemes are more generous, sometimes providing up to two-thirds of previous income for a limited period).

The Covid-19 job retention scheme unveiled by Mr Sunak last week was, in a British context, revolutionary. For the first time the British government is prepared, without limit, to pay the wages of private sector employees who are laid off. It will enable employers to put staff onto ‘furlough’, rather than making them redundant, with the state paying 80% of their previous income up to a maximum of £2,500 a month. This retains the link between employee and organisation, and ensures that when demand returns there will be capacity to meet it.

Income support schemes strike a balance between getting timely help to those in need with covering as many people as possible. In the UK’s case, 4.7m self-employed people are not covered by the Covid-19 income support scheme since they are outside the PAYE system. Yesterday the communities secretary Robert Jenrick said that the UK government was looking at extending the new scheme to the self-employed though doing so was, he said, “logistically and operationally” difficult.

To get round such problems governments could simply give a lump sum to every taxpayer or household. This has the advantage of being quick and comprehensive, but it is also expensive and untargeted. Hong Kong and Singapore have taken this route; support is growing in the US for a similar policy.

Whatever form it takes, help will need to come quickly. Weekly claims for unemployment insurance in the US have surged and the US treasury secretary, Steven Mnuchin, has warned that the US unemployment rate could rise to 20%.

But no amount of government spending or monetary ease will be able to offset the immediate shock to growth. Goldman Sachs estimates US GDP is likely to contract by 7.5% in the second quarter. In economic terms this is off the scale, literally. On the chart of US GDP we run on the Datastream system the largest previous decline since 1953, in early 1958, was 2.6%. At the height of the financial crisis in the fourth quarter of 2008 US GDP contracted by 2.3%.

We’ve been looking at the possible effects on the UK economy in the second quarter. My colleague Max has gone through the GDP data and made some rough estimates of the possible sectoral effects, which in areas like tourism, hotels and leisure will be acute. Max’s calculations suggest a decline of 10% or more in UK GDP could be possible. That would be four times as great as any previous contraction in the last 60 years. On the employment side my colleague Debo estimates that there are over 4m jobs in the most vulnerable UK sectors, such as hotels, non-food retail and travel; many more, of course, are in related sectors. Certain jobs, including just under 5m self-employed people and more than 12m in small businesses, are also more likely to be vulnerable than those in large businesses and the public sector.

The message from policymakers and politicians in the last week is that they will do whatever it takes. That implies large scale interventions and unorthodox policies. This will necessarily entail a significant extension of the role of the state and its involvement in everyday life. Public spending and debt levels are set to increase sharply. We are not at the point where central banks fund governments directly by printing money, or, strictly speaking, issuing it. But central banks’ asset purchases will have a similar result as they mop up new debt issued by governments.

Policymakers have learned two of the big lessons of the financial crisis – to act in scale and deal with the bill later. The question is whether they will be able to apply one of the other lessons – the need to get help to the right parts of the economy and financial markets at speed.