When four of the world’s most influential economic policymakers spoke at a San Diego conference on January 5 this year, an insidious new virus was spreading 7,000 miles away, infecting the market traders of Wuhan in central China. But while they were largely unaware of what was coming, they were already concerned.
Mario Draghi, Lawrence Summers, Janet Yellen and Adam Posen played leading roles in rescuing the global economy after the financial crisis of 2008-09. More than 10 years later, they were not confident about the ability of their successors to do the same.
The US Federal Reserve, which Ms Yellen used to chair, had already been forced to cut its target interest rate to a range of 1.5-1.75 per cent during 2019 because of concerns about global growth. Mr Draghi’s European Central Bank and the Bank of Japan still had negative interest rates, despite a decade of aggressive monetary stimulus. If any kind of shock were to hit the economy, there was little room to respond.
“All four of us said ‘fiscal policy’, not having any clue coronavirus was coming,” says Mr Posen, a former BoE policymaker who is now head of the Peterson Institute in Washington, describing the panel at the American Economic Association’s annual meeting.
Just weeks later, that shock arrived. First coronavirus ripped through Wuhan, prompting perhaps the largest quarantine in history and all but shutting down China’s economy. Then the number of cases began to rise around the world, slowly but inexorably, prompting the OECD to warn this week of a global downturn.
On Tuesday, the Fed began to use its firepower, slashing interest rates by 50 basis points after a determined effort at international co-ordination. But while the G7 group of rich countries promised “to use all appropriate policy tools”, and the Bank of Canada swiftly followed the Fed, moves from the ECB and BoJ were notable by their absence.
As well as its consequences for public health, therefore, coronavirus may mark a watershed for economic policy. After almost half a century when central bankers were the heroes, and monetary policy was the main tool for managing demand, they are actively calling for the use of fiscal policy instead.
At his confirmation hearing this week incoming Bank of England governor Andrew Bailey said the UK central bank has some monetary tools still to use. But if it was asked to act alone without fiscal support, “it would strain the bounds” of monetary policy, “calling into question the effectiveness of the institution that deploys it”. He urged the government to use fiscal policy in such circumstances.
“Whether or not this emergency [Fed] cut works . . . there’s no question that this is a situation in which monetary policy is likely to be particularly ineffective,” says Mr Posen.
A pandemic generates an unusual economic shock because it first hits supply, not demand. A closed factory and a quarantined workforce cannot make cars or mobile phones, no matter how many people want to buy them. Reopen the factories, however, and supply should soon bounce back. Many economists therefore hope for a speedy recovery — if the virus can be tackled.
One policy to handle a shortlived supply shock is loan forbearance, so companies suffering from a sudden shutdown in sales are not driven into disruptive failures because they miss debt payments. China’s banking regulator has called on lenders not to classify overdue loans as bad debt for companies struggling through the crisis.
The danger, however, is that a supply shock turns into a demand shock as consumers cease to travel or shop, and companies are forced to lay off workers, creating the dynamics of a recession. Yields on 10-year US Treasury bonds briefly fell to a record low below 0.7 per cent on Friday, illustrating market fears that the coronavirus is not just a supply problem, but a lasting blow to demand.
“[Rate cuts] won’t fix a broken supply chain,” said Jay Powell, the current Fed chair, at a press conference after his rate move this week. “We get that. We don’t think we have all the answers. But we do believe that our action will provide a meaningful boost to the economy.”
The Fed at least has space to cut rates. It could also restart quantitative easing — asset purchases aimed at driving down longer-term interest rates — if the situation worsens. But in Europe and Japan the debate has already turned to government action.
“When you have the risk of recession — like in Germany, where you have had several quarters of weak growth — you could start to see reduced political opposition to a fiscal stimulus,” says Danae Kyriakopoulou, chief economist at central bank think-tank OMFIF.
“It is all about fiscal policy now,” says Olivier Blanchard, a former IMF chief economist. “We should not hesitate to spend even 5-10 per cent more of gross domestic product and that should not create any worries about debt sustainability, providing it is spent sensibly.”
Interest rate cuts would have little more than “symbolic” value, he says, as they are unlikely to persuade companies to invest more or households to save less given the widespread concern over the virus. With fiscal policy, governments can target spending where it is needed, for example by giving wage subsidies to parents who cannot work because schools are closed.
Yet despite years of warnings that fiscal policy would be needed in the next downturn, few countries are willing and able to act. Guntram Wolff, director of the Bruegel think-tank in Brussels, says the eurozone’s response so far has been “weak” compared with a €200bn fiscal stimulus after the 2008 financial crisis. “I think it is coming too late,” he adds.
A major hurdle to any big fiscal stimulus in Europe is Germany. Despite having one of the lowest debt-to-GDP ratios in the region, Berlin has continued to run large budget surpluses, even after its export-heavy economy narrowly avoided a recession last year.
French officials argued that this week’s eurogroup statement, which said the EU was prepared to temporarily relax its fiscal rules in response to the virus, would have been weaker if they had not pushed to remove the most cautious language. Against a backdrop of bickering over the EU’s €1tn budget, many observers think there is still little prospect of Germany loosening its purse strings much — especially as chancellor Angela Merkel’s coalition government seems beset by uncertainty over who will succeed her.
“I think it will have to get a lot worse before there is political will in the Bundestag in Berlin to accept a significant fiscal stimulus,” says Mr Wolff.
In the US, Congress passed an $8bn coronavirus emergency bill but staffers from both parties say Capitol Hill is still focused on the immediate public health crisis and only just beginning to contemplate the collapse in demand that might follow. “It’s changing quickly,” says one. “It’s a hell of a time.”
On Tuesday, President Donald Trump floated the possibility of a payroll tax cut, but he has staked his re-election on historically low unemployment. To contemplate an economic rescue package would be to contemplate an economy that needed rescuing.
“We would prefer a targeted approach,” Larry Kudlow, director of the National Economic Council, told CNBC on Friday. “Let’s think about individuals who might lose paycheques because they have to stay home if they get the virus. Let’s think about small businesses that might get hurt by this. I just don’t want to panic.”
“The White House is not up to this right now,” says Joe Brusuelas, RSM’s chief economist who has good contacts with policymakers, including some in the administration. “They don’t want to do a fiscal package.”
Mr Brusuelas says there is no talk at all within the White House of a drop in demand or a decline in sentiment as the virus spreads. “That’s the most frightening thing,” he says. “They’re not willing to concede publicly that there will be profound second-order effects.”
That leaves China, the origin of the virus, which has suffered the worst economic blow so far. The People’s Bank of China has resisted calls to unleash a full stimulus and instead conducted only some targeted easing. “China’s monetary policy easing is helpful but it’s not enough to make the Chinese economy, not to mention the global economy, bottom out,” says Larry Hu, head of China economics at Macquarie Group.
Economists hope for more fiscal stimulus instead. Beijing has pushed forward to earlier in the year the allocation of bonds to spend on infrastructure projects. As the world’s second-largest economy, a renewed building boom within China could drive global demand for resources, but there is little sign of such activity in commodity markets.
With governments so recalcitrant, says Mr Posen, central banks jump in because they are on the losing end of a game of chicken: they act, even with imperfect tools, because they do not believe that the fiscal authorities are willing to. It is remarkable that “an elected government can credibly threaten that ‘we’re not going to spend on our people’, but actually that’s the reality,” he says.
Mr Posen points to the US failure to fix tainted water supplies in Flint, Michigan, British austerity measures after the financial crisis, and German reluctance to spend on infrastructure as examples.
“It’s actually much more credible for whatever bizarre reason that governments will not respond to events,” he says. If central banks truly do stand aside, then the coronavirus will provide the stiffest test of that passivity.
Additional reporting by Don Weinland in Beijing, Guy Chazan in Berlin and Chris Giles in London