It’s clear that the Covid-19 pandemic will cause a severe hit to economic activity. The question is whether it will be short-lived or prolonged.
In a webinar last Thursday we polled about 4,000 people from businesses, other organisations and Deloitte. Just under 80% expected a significant but temporary hit to economic growth, with most expecting activity to come back in the second half of this year.
For now that seems the most likely outcome. But the unprecedented nature of the disruption to normal life means growth is likely to shrink significantly in the meantime. The UK government, for instance, believes that up to 20% of Britain’s workforce, through illness, caring for others or self-isolation, could be off work at any one time. Even if growth comes back some countries will experience a severe contraction in activity in the first two quarters of this year.
To avoid a worse outcome policymakers need to calm financial markets and help households and businesses through the crisis. Last week’s turmoil in financial markets signals that policy and communication are behind the curve.
The decision by the US to suspend flights from continental Europe to the US came as a shock to other governments and airlines and contributed to one of the worst-ever days for equities. The European Central Bank’s new president, Christine Lagarde, panicked markets by suggesting that the ECB might be unwilling to support the Italian government debt market.
In a tumultuous week the policy moves from the UK did look convincing and coordinated. On Wednesday the Bank of England eased monetary policy aggressively hours before a budget which delivered a substantial fiscal boost to the economy.
In any crisis there will be missteps and errors. But the big picture is clear. A vast easing of fiscal and monetary policy is underway around the world. Yet it is not fully commensurate with the scale of the threat. We need more aggressive action.
In the coming weeks central banks are likely to step up asset purchases, or quantitative easing programmes, in a bid to drive down interest rates and increase liquidity. Where interest rates are in positive territory they will be cut. The Federal Reserve cut interest rates by one-percentage point last night. Financial markets will need to be calmed with further injections of liquidity. Last Friday the German government pledged to provide unlimited loans to businesses hit by the crisis; other governments need to follow this lead.
These are essential responses from the central bank playbook. But the economic shock from Covid-19 is unique. It is not the situation of deficient demand and underused resources described by Keynes in the 1930s. Nor is it a financial crisis, where the bursting of a debt and asset price bubble causes a credit crunch. Today people who would otherwise be working, earning and consuming will be unable to do so because of restrictions on movement. Revenues for the businesses and sectors that rely on them are vanishing. This is a crisis of household incomes and corporate revenues.
This calls for a different set of tools. Governments will need to borrow to provide households and businesses with the cash they need to keep going. Only governments have the heft and scale to solve this problem.
The delivery mechanism will vary by country, but the tax and benefit system is the obvious starting point. European countries have developed welfare systems which enable governments to target help to those most in need. Rules, rates and eligibility will need to flex (the UK, for instance, could temporarily suspend means testing for the main benefit, Universal Credit). In the US the Supplemental Nutrition Assistance Program (SNAP) can channel help to vulnerable households quickly. In the event of school closures, children who previously received free school meals will need alternative provision. Payroll taxes can be cut; president Donald Trump wants to delay the 15 April deadline for paying taxes. Wider and more generous entitlement to sick pay, and in the case of the US, healthcare, is essential.
But many people outside the benefit system are likely to come under pressure. Governments may need to offer new schemes to support those whose incomes suffer as a result of illness, absence or being laid off.
Last Friday Portugal’s government introduced a scheme which will pay employees who stay at home to look after children under 12 two-thirds of their salaries, with the cost borne equally by employers and the state. France, Japan, and Korea are adopting similar schemes. The Singaporean government is helping pay the wages of private-sector employees for three months.
A more dramatic approach is give each household or taxpayer a lump sum. Hong Kong’s government has given every adult about $1,000. Last week Jason Furman, the former economic adviser to president Obama, argued that Congress make a one-off payment of $1,000 to every adult and $500 to every child, noting that president George W Bush had created a similar scheme in 2008.
Many countries are easing taxes or social security charges for businesses. Some sectors will need much more extensive government support. There are precedents. In the US federal aid helped airlines in the wake of the 9/11 attacks and kept banks and automakers afloat in the global financial crisis.
Twelve years ago, during the financial crisis, monetary policy ease came to the rescue. This time fiscal policy, government spending, will have to do the heavy lifting. Government borrowing will have to take the strain.
As in any crisis, the response will need to address the unfolding challenges. There will be missteps. But contrary to what is sometimes said, policymakers have tools to combat this crisis. Many countries are already deploying them, but more needs to be done. Announcing a vast programme of loans to help business last week Germany’s finance minister described it as a big “bazooka” to head off a crisis. It is an apt metaphor. Policymakers everywhere need to deploy the big bazooka.