Politics blocking new fiscal stimulus
The economic recovery in developed economies hinges on several important factors. Most importantly, they include the path of the virus and government responses to it. In last month’s Economic Monitor, we suggested that the pace of economic recovery may have reached a high-water mark in June, with a flare-up in daily cases of coronavirus to above 70,000 in the United States being our primary concern. Since then, the situation has improved, with new daily cases dropping below 50,000. Yet this remains the highest in the larger nations of the developed world. The trends in Europe though have decidedly worsened, too, with over 70% of countries experiencing growth in the past week. In Ireland, we know too well how this can impact on policymakers given this week’s announcements, even if Ireland seems to be consistently among the more cautious in reaction to the spread of the virus.
The economic impact of the shutdown, although severe, was cushioned by large government programmes and aggressive monetary responses everywhere. The US, after a slow start, introduced the most aggressive fiscal response in the form of its $3 trillion CARES Act. This funnelled cash to businesses and to workers impacted by the pandemic and subsequent lockdown.
It had a dramatic impact on consumers in particular. The chart below shows how despite a 10% reduction in compensation of employees in April due to job losses, personal incomes in the US rose by 10% thanks to a doubling of government transfers. This mainly came through additional unemployment assistance that entitled people to an extra $600 per week in support. Despite this surge in government assistance, the household savings ratio spiked to 34% in April, falling to 19% in June. However, there are important compositional factors here: those in the higher-income brackets, who were less likely to have been impacted, have seen savings spike. Those more likely to have needed the additional unemployment assistance had a higher propensity to consume. Consumer spending, which accounts for the vast bulk of US GDP, is thus vulnerable to the cessation of these payments.
These payments ceased at the end of July, and although President Trump has authorised a temporary (reduced) payment, there is no certainty about the policy beyond the end of this month. This is due to the ongoing disagreements between Republicans and Democrats on the next fiscal package. Democrats were initially proposing a package worth $3 trillion, with Republicans at $1 trillion. It appears that this gap has been closed somewhat, but important differences remain.
Given the imminency of the election, it is unlikely that politicians on either side want to be blamed for another spending slump and voter unrest. That is why we still believe a deal will be done. Given the ongoing buoyancy in equity markets, it is likely that the market is also expecting a deal to be done. The current state of US politics makes a prediction on the scale and timing of such a deal very difficult.
Former ECB president Mario Draghi returned this week for his first public appearance since ending his eight-year stint in 2019. In his usual articulate and lucid way, Draghi sent the current crop of policymakers some important advice about how best to manage the crisis. Having navigated the euro area through its most torrid time during the 2011-2013, his advice is very much worth heeding (link to speech).
The speech is littered with historical references, such as to the wars, the global financial crisis and the euro sovereign crisis, but we take away three key pieces of advice that are relevant to how policymakers may deal with today’s crisis. Some of this advice is already being followed. Some of it needs to be.
- The crisis needs flexible thinking and innovative solutions… Such is the speed and severity of the economic downturn, that sticking rigidly to orthodox thinking on economic and fiscal policy risks exacerbating and prolonging the downturn. In this regard, policymakers in this crisis have shown themselves to be pragmatic in introducing monetary and fiscal boosts the likes of which we have never seen before. These measures have cushioned the blow for workers and businesses and for that they deserve credit. In a European context, it was feared that fiscal rules would hamstring national governments from making these kinds of decisions, but the European Commission has shown pragmatism in suspending the rules for 2020 and, most likely, for 2021. With pooled resources also likely to be used for the first time, the cohesion shown in the bloc is a welcome and surprising feature of this crisis.
- …but all principles learnt from the past should not be abandoned. While not a recent development, Draghi is critical of how many of the principles and institutions that have been developed over the course of decades since the second world war have been vilified in certain quarters. In some cases, they have been used as excuses for failures of domestic policy. He is referring here to: (1) the US decision to question to jurisdiction of the WTO and to pull back from multilateral relations more broadly, and; (2) the UK’s decision to exit the largest trading bloc in the world as it was being blamed for stifling the country from achieving greater economic progress. His message was this: “We must affirm our adhesion to Europe and its rules of responsibility, but also recognise our common interdependence and solidarity; we must recommit to multilateralism and a global rule of law.”
- There is “good” debt and “bad” debt. The third takeaway is the key one. The substantial rise in government debt levels due to crisis-related spending is sustainable, but only if the money is put towards productive uses. As evidenced by this week’s sale of German 30-year bonds at a yield of -0.05%, money, even for a long period of time, is free or even at a negative cost. This has been facilitated by the actions of the ECB. But it is not a panacea. In the first instance, Draghi urges governments to protect the vulnerable to ensure social cohesion. However, resources must also be put into productive uses. In the aftermath of World War II, this took the form of a large-scale reconstruction of physical infrastructure in Europe. This time around it should take the form of a large-scale investment in human capital. Education is seen a critical for growth in productivity and thus economic growth. If economies are to prosper and the debt is to be paid back in the future, governments must have a renewed focus on raising the productive potential of their economies.