Policy is about to get much harder
A certain stall is appearing in the economic activity of the major advanced economies, shaping what is emerging as a third phase of the Covid19 crisis. In contrast to the first two phases, shaped by a collapse in activity under stringent lockdowns and then a sharp bounce-back as lockdowns were eased, this third phase, of a still active virus and more localised restrictive measures, could well be with us for much longer and make far greater demands on policy.
Michala Marcussen, Group Chief Economist and Head of Economic and Sector Research
The initial policy response to offset the cost of lockdowns differed across countries but shared the common goal of protecting corporates from collapse or hostile takeovers and supporting household incomes. These policy packages, moreover, were generally large in size, comprised primarily of temporary measures and fairly indiscriminate in design. Given the scale of the shock and the speed at which it occurred, this was appropriate.
With the health crisis still ongoing, a number of these temporary measures have been extended, but this has not been without friction, with the starkest example coming from the United States, where Congress failed to agree an extension of the supplementary $600 per week unemployment benefit that expired at the end of end July. President Trump’s executive order allowing up to $400 per week offers partial relief only and draws on the $44bn disaster relief fund on which could run out of funds in just a matter of weeks. This leaves households at risk of considerable uncertainty.
More encouragingly, France, Germany and Italy have all secured extensions for their respective worker support schemes, with Italy seeking support from the European Union’s new SURE unemployment mechanism. Common to all countries is the concern that running such measures for a very extended period of time will add significant strain to public finances.
Corporates also stand to benefit from the extension of various temporary support measures, but if designs are not modified, a mere extension of government guaranteed loans or various moratoriums will simply see corporates pile on more debt, which will ultimately threaten solvency and trigger a wave of corporate defaults and permanent job losses. To avoid such a scenario, governments need to ensure that sufficient demand is directed to the corporate sector even in a scenario will a lingering health crisis. It is important furthermore to prevent zombification, whereby resources become trapped in unproductive firms leading to aggregate low growth and risking greater inequality.
Boosting public infrastructure investment, and not least those to aid digital and green transitions is an attractive solution and sits at the heart of Europe’s recovery plan. Next Generation EU. Rolling out such programmes in practice, however, brings numerous challenges ranging from the sheer logistics of approving projects, securing skilled workers and ensuring that the projects selected come with right enabling policies to secure positive multiplier effects across the economy. The sheer magnitude of the current shock means that all of this has to happen at unprecedented speed and with an eye as to how to address unintended consequences given the very significant transition risks involved, be it for workers, individual sectors or global supply chains.
While it is encouraging to see political consensus emerging across many advanced economies to roll out such public investment programmes in various forms, this new phase of the policy response to the Covid19 crisis comes both with far greater risks on implementation and premature cut off. Indeed, such policies will have to run well beyond any initial recovery, and this will require moving previous “red lines” on policy rules and practices. The prize will be worth combatting these numerous policy challenges as this is precisely what many economists have long urged to break secular stagnation.