Global Policy Makers Face a Choice: Protect or Reinvent

Finance ministers had one big job in the first months of the Covid crisis: “filling the hole.” To keep the economy on life support they needed to work out the likely hit to incomes then match it with government cash. Doing that well was not so difficult, just ruinously expensive. But the job now is to help the economy grow out of lockdown. That may or may not be cheaper, but we can see already it’s a lot harder.

Just ask U.K. Chancellor Rushi Sunak, under fire now both for spending too much money in his summer statement and for spending too little. It’s a sign of just how difficult this stage of the crisis might be that both criticisms are probably right.

History may well show he wasted billions rewarding employers for rehiring furloughed workers they would have taken back anyway. But it is also quite likely to show that £30 billion (1.5% of GDP) in extra stimulus was not nearly enough to safeguard the recovery. He will not be the last finance minister to discover he was damned if he did, and damned if he didn’t.

Unanswered Questions

To design theperfect economic plan for this stage in the crisis, policy makers need, first, to know how well the virus is going to be controlled in the coming months and the maximum potential output of the economy under conditions of social distancing.

61,352 in U.S.Most new cases today

-6% Change in MSCI World Index of global stocks since Wuhan lockdown, Jan. 23

-1.​106 Change in U.S. treasury bond yield since Wuhan lockdown, Jan. 23

4.​4% Global GDP Tracker (annualized), June

We do not have an answer to those. But it’s a fair bet that demand currently falls short of what’s possible in most economies that have come out of formal lockdown. Is that because households are worried about holding on to their jobs or catching Covid-19? For the right economic plan, you need to know the answer to that too.

To give effective support to workers you also need to know roughly how many of the jobs and businesses that have been since the start of the crisis are not coming back. Put simply: you need to know how much of the economy is still worth protecting and how much we will need to reinvent.

No one is expecting the perfect plan, from the U.K. chancellor or anyone else. But to rise to this new stage of the crisis, finance ministers do need to take a view on these questions — even though, for every one of them, it really is too soon too tell. Officials may look back with some nostalgia to the time when all they had to do was “fill the hole.”

Filling in the Holes: G-20 Income Shocks and Fiscal Support

The gulf between developed and emerging economies is likely to widen even further in this new stage of the crisis. As the chart shows, advanced economies’ fiscal and monetary support has often matched or exceeded the likely short-term economic hit. Among emerging-market countries, China and Indonesia managed the same feat. Other emerging markets came into the crisis weaker and their response has fallen far short. Without more global support, they could suffer a permanent hit, as Bloomberg Economics’ Ziad Daoud has described.

But even rich governments with ample capacity to borrow on world markets and credible, supportive central banks are likely to find things are much messier from now on. This leads to a new commandment for the next phase of the crisis: Don’t create extra obstacles to recovery on top of those caused by Covid-19.

Central bank governors and finance ministers can’t do much directly to prevent a second wave of infection. The timetable for moving out of lockdown and loosening social distancing guidelines largely isn’t up tothem either. But there’s still plenty that economic policy makers can do to improve the outlook — or make it worse.

Removing support too quickly is an obvious mistake to avoid. Where monetary policy is concerned, there seems little risk of that in 2020. The major central banks are all expected to maintain their exceptional support to banks and the broader economy at least through the end of 2020.

Some have suggested inflation is more likely now than after the global financial crisis. That may be true. But deflation is still enemy No. 1. Current market expectations are for annual inflation in the developed economies to average about 1.5% over the next five years. Undershooting that level by 1 to 2 percentage points would be catastrophically worse for the global economy than overshooting by a similar amount. Monetary authorities, especially the European Central Bank, should make this crystal clear in their messaging about policy.

Fiscal Support

Managing the fiscal side of the recovery is more complicated, as the U.K.’s Sunak discovered with his summer statement. It’s not sustainable for governments to maintain the same level of support until their economies get all the way back to where they were.

This isn’t a matter only of what’s affordable, though even the U.S. probably can’t run a budget deficit of more than 15% of gross domestic product indefinitely. The deeper issue is that many of the Covid-19 stimulus packages weren’t designed to “stimulate” the economy at all. They were meant to keep everything on hold.

That’s the right thing to do during lockdowns. It could also be helpful in the early recovery phase if, by protecting the incomes of furloughed workers, you’ve put money in their pockets that they’ll spend. But you can’t afford to discourage employers from bringing people back to work in sectors that might otherwise be on the mend.

This is critical for the U.K., where a temporary job retention scheme is paying most of the wages of almost 9 million people — 25% of the country’s workforce. At least some of those people would probably be working part time if the program were better designed. Introducing more flexibility, beginning in August, will better support the recovery. But refusing to extend the scheme for those sectors most affected by social distancing is quite a gamble.

In theory, paying unemployed U.S. workers extra benefits, which in some cases amount to more than 100% of their previous wage, could also stand in the way of the recovery by discouraging them from looking for a job. But the much larger risk for the U.S. in the second half of 2020 is that paralysis in Congress will lead to federal support for households being removed too quickly — just as states cut spending and lay off workers to meet legal mandates to balance their budgets.

An early end to business support programs seems less likely. As we move through the initial bounce-back phase, there will be greater concern that these are keeping “ zombie companies” afloat and discouraging important adjustments. This has long been an issue for Europe and Japan. It’s surely a greater risk now in the U.S. than before given the sheer scale of cheap liquidity to businesses, either directly through federal loan programs or via the Federal Reserve’s promise to buy corporate debt.

Escalating Debt

More investment-grade debt — nearly $1 trillion — was issued by U.S. companies in the first 50 days of 2020 than in the first 11 months of 2019. Encouraging even healthy companies to pile up more debt isn’t healthy long term and risks making it that much harder to tighten monetary conditions later. Short-term grants and/or more equity-like support would be better. But it’s not the way most governments have gone.

In an ideal world, governments would pursue a twin-track strategy by offering targeted support to the 5% to 10% of the economy worst hit by social distancing, and more traditional safety nets for everyone else. But drawing the line between the two will be tricky.

The longer social distancing is in place, the greater the chance that businesses will find ways to adapt. Governments need to encourage this kind of adjustment while not forgetting the corners of the economy — live theater, parts of the hospitality industry — that can’t operate while Covid-19 remains a threat.

To invest in the long-term health of the economy, not only will the most affected sectors need careful support, but the worst affected people will, too.

Bloomberg Economics’ analysis of the scale of the reallocation shock, plus what we know about the long-term costs to younger workers of being unemployed at the start of their careers, highlights the importance of imaginative training and retraining programs for young people affected by the crisis. These could ultimately be just as important as propping up ailing companies.

Getting all these judgments right will indeed be difficult. But added together, they will make an enormous difference to the shape in which countries find themselves in 2021 and beyond. Inevitably the focus will shift to the long-term legacy of the crisis for government balance sheets, the long-term credibility of central banks, and the scope and resilience of global supply chains. But voters will be more focused on how well the most vulnerable parts of society have been protected.

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