This article is part of a series in which leading commentators and policymakers give their advice on alleviating the devastating global slowdown
The writer is a former head of the UK Financial Services Authority
Our overriding priority during the coronavirus pandemic must be to save lives. But we must also reduce the economic impact, preserving employment and incomes as best possible. A significant hit to global growth is inevitable, but with forceful and focused policy we can limit harm.
As in the global financial crisis of 2008, we need to understand the balance between the three categories of problems that we face: liquidity, solvency and deficient demand. Liquidity problems in either the financial system or real economy can be offset by forceful central bank action, and several appropriate policy packages have already been announced. Among them are: cutting interest rates to zero; lending central bank money to commercial banks to allow them to lend it on to businesses; and releasing banks’ countercyclical capital buffers so they can lend more. Together these actions can ensure that fundamentally sound businesses are not driven to bankruptcy by a lack of credit.
But they will be insufficient to avoid major solvency problems in specific sectors. If bars, restaurants, hotels and airlines have no customers for two months, no amount of cheap credit can prevent eventual bankruptcy. If staff are kept on, corporate losses will accumulate rapidly. If workers are laid off in large numbers, they will cut their spending even on sectors such as online shopping or entertainment that could be buoyant in a stay-at-home economy. Without offsetting action, we will face a deflationary cycle of falling consumption and income.
Monetary policy can do almost nothing to offset these dangers; with interest rates already rock bottom, further small cuts will foster neither business investment nor consumer spending. Only fiscal expansion can make a major difference. This mirrors our experience in 2009, when fiscal deficits of more than 10 per cent of gross domestic product in Japan, the US and the UK, and 6 per cent in the eurozone, were essential to avoid a sustained and deep depression.
Clearly, fiscal stimulus must involve whatever increases in health service expenditure are needed. In countries with strong welfare states, public spending will increase automatically as sick pay and unemployment claims rise. In the US, the White House has opened talks with Congress on a $1tn stimulus package that includes sending cheques directly to individual households, boosting their cash balances.
Such payments should have been used more widely in 2009. Now they could help to offset economy-wide contractions in demand. But even that would be insufficient. While demand in 2008 was threatened by a collapse in consumer and business confidence, today’s quarantines and lockdowns mean that even people with plenty of spare cash cannot go out and spend.
Many of those in secure jobs now working from home will accumulate cash savings as salary payments continue while spending opportunities shrink. But improved balance sheets for some households will not prevent large-scale bankruptcies and job losses in the most affected sectors. Physical constraints on consumption are the crucial, and new, feature of this crisis. They imply the need for targeted action in addition to economy-wide stimulus.
It is time for employment subsidies to support companies that maintain payrolls and direct financial support aimed at the sectors facing greatest stress. Waivers of business taxes, or grants to assist with rent payments where companies have had to close their doors, must play a crucial role alongside cheap finance.
Governments are usually wary of such sectoral preferences, but it is clear which sectors are most affected by travel bans, curfews, self-isolation and social distancing, and the need for sectoral preferences will be clearly time limited. When governments can allow people to return to bars and restaurants, support for such sectors can cease.
Further fiscal support will subsequently be required to drive economic recovery, but the emphasis should then switch from sectoral specific subsidies to long-term infrastructure investment, ideally in ways that also drive progress towards reducing emissions and low carbon economies.
All this implies big fiscal deficits and potential increases in already high public debt to GDP ratios. But with government bond yields close to zero, most developed nations face no short-term financing constraint. For countries with national currencies, central bank monetary financing of temporarily increased fiscal deficits is a feasible option. This would provide strong stimulus without increasing the public debt burden. The eurozone’s structure and rules inhibit explicit monetary finance but creative ways must be found to allow the ECB to support members’ fiscal expansion. For the developed world, at least, finding the money is not the key problem.