As the novel coronavirus pandemic sweeps the world, countries have rightly recognized the need to take dramatic measures to “flatten the curve”—that is, to slow the rate of infection, avoid overwhelming health-care systems, and in so doing save many thousands of lives.
But these necessary public health measures have also triggered chaos in the global economy. “Social distancing” efforts have placed sudden and existential pressures on businesses, caused historic turmoil in global capital markets, and fanned widespread fear of recession—or worse. Growing numbers of forecasts now predict economic and financial pain on par with the global financial crisis of 2008 and 2009 and possibly approaching the levels of the Great Depression that lasted from 1929 to 1933. Central banks and fiscal authorities around the world are scrambling to prevent such a scenario, but many of their policies have been vaguely articulated, will be difficult to implement, and have been poorly received by investors.
The right policy response to the coming coronavirus recession must start with the right diagnosis of the economic shock that the pandemic has caused: a broad, deep collapse in household demand for consumer goods and services. The best way to counter this shock is to take three interrelated measures: invest in stopping the spread of the new coronavirus, backstop businesses hit by collapsing consumption, and make every effort to avoid a financial crisis. How much will all this cost? Done swiftly in the United States, the total cost of this plan is likely to be somewhere between $1 trillion and $2 trillion—borne mainly by the federal government in the form of increased indebtedness. Without a sufficiently integrated and ambitious response, the economic contraction on the horizon could end up known as the Coronavirus Depression.
WORSE THAN A RECESSION?
Throughout history, recessions have typically occurred when aggregate demand for newly produced goods and services has fallen below the economy’s capacity to supply them. The shortfall results in idle factories and unemployed workers, which in turn puts pressure on individuals, families, and communities.
In the standard national income accounting that almost all countries use, aggregate demand is broken out into four main categories: consumption demand, which comes from individuals and households; investment demand, on the part of companies; government demand; and net exports, or demand originating in the rest of the world. Drops in investment demand cause the majority of recessions, and those drops are often occasioned when central banks raise interest rates.
The coronavirus recession, when it arrives, will be unusual in that it will be caused by plummeting household demand. Social-distancing interventions—from recommendations to limit the size of social gatherings to military-supported lockdowns—impede people’s ability to purchase many of the goods and services they normally purchase. The result is a dramatic fall in consumer demand that depresses overall aggregate demand and plunges the economy into chaos.
Consider what happened in China, where the new coronavirus first appeared in late 2019. Retail sales of all goods plummeted 20.5 percent year-over-year in January and February, when hundreds of millions of people were placed under lockdown. For automobile sales, the decline was nearly 80 percent. Analysts now expect overall Chinese GDP to contract at an annualized rate of 10 percent or higher in the first quarter of this year.
The blow to consumer demand could be just as severe, if not more so, in the United States. In 2019, U.S. GDP totaled $21.43 trillion, of which household consumption accounted for $14.56 trillion—or 68 percent. In order to help flatten the curve, Americans are now being urged—and in some states ordered—by public health officials to effectively stop being consumers: stop eating out at restaurants, stop flying on airplanes, stop going to movies and shows. Add up 2019 U.S. consumption of food services and accommodations ($1.02 trillion), recreation services ($587 billion), and transportation services ($478 billion), and there alone is $2.09 trillion, about a seventh of all consumption and nearly 10 percent of total GDP. Of course, the figures won’t fall to zero in all of these categories, but they will fall dramatically, and the ripple effects will extend far beyond these hardest-hit sectors.
The largest quarterly GDP contraction ever recorded in the United States was -8.4 percent (annualized), in the fourth quarter of 2008. If the coronavirus crisis ends up lasting three months, in other words, its effect on household consumption alone could cause a GDP contraction on a par with the worst quarter in U.S. history. But the blow to total aggregate demand could be even heavier than that. Consumers might cut back their spending in other areas, such as automobiles and other big-ticket durable goods, as they did in China. Last year, motor vehicles and parts ($531 billion) and furnishings and durable household equipment ($418 billion) accounted for nearly $1 trillion in consumer spending.
The coronavirus crisis’ effect on household consumption could cause a GDP contraction on a par with the worst quarter in U.S. history.
Companies could respond to plunging consumer demand by cutting capital investment. Many will also have to lay workers off, compounding the shock to aggregate demand. As of February 2020, food services and accommodations alone employed nearly 14.4 million workers—11.1 percent of total U.S. payroll jobs. Air transportation employed more than half a million people; arts and entertainment, 2.5 million; and retail trade, 15.7 million. In recent days, the waves of furloughs, cuts to hours, and layoffs have begun. Unemployment hit a high of 10 percent during the 2008–9 global financial crisis; it may well go higher in a coronavirus downturn. And of course, these labor-market pressures will disproportionately affect those who are vulnerable to begin with: those with less wealth that might cushion them through a downturn.
The collapse in aggregate demand and the resulting layoffs could set off another financial crisis as businesses and workers struggle to meet their debt obligations. The American businesses that will feel this pressure will span the spectrum, from the largest multinational companies to the smallest neighborhood establishments. In 2017, the U.S. census of American firms counted 539,886 firms in food services and accommodations. More than 76 percent of these firms—413,464—employed fewer than 20 people. Companies, workers, and families will all suddenly have almost no revenue or income with which to pay their creditors. Large multinationals will struggle to make payments on bonds, unsecured short-term loans, and other forms of debt they have taken on. Small-business owners will struggle to pay their mortgages and other loans they have taken out from local banks. Individuals and families will struggle to keep current on their student loans, credit cards, and mortgages.
Left unchecked by an aggressive policy response, the coronavirus crisis is likely to be worse than the Great Recession that followed the global financial crisis of 2008–9. And if the economic shock of social distancing ends up triggering a financial crisis, it could rival the Great Depression, when U.S. GDP contracted 30 percent between 1929 and 1933 and unemployment peaked at 20 percent. Without a plan to fight it, in other words, the coronavirus recession could easily become a depression.
To avert such an outcome, the United States should take three interrelated steps. First, the federal government should marshal all of its moral and legal powers to support the health-care system and shorten the time period over which social-distancing measures are needed. The longer drastic restrictions on people’s mobility are in place, the deeper and more economically dangerous will be the drop in consumer spending. An annualized decline in U.S. consumption of between $2 trillion and $3 trillion translates into a loss of roughly $10 billion every business day.
So the U.S. government should invest: in producing more test kits, providing more hospital beds, and purchasing more respirators, gowns, and other equipment. It should invest in discovering and developing a coronavirus vaccine. The administration of U.S. President Donald Trump and Congress should summon all of the leaders of these interrelated efforts—from the private sector, federal agencies, and state and local governments—to coordinate, fund, and motivate them. The Trump administration should also use the power granted under the Defense Production Act to relax antitrust considerations and allow companies to work together to speed up and maximize the output of medical equipment and vaccines. It should also eliminate any and all trade barriers that are impeding foreign-produced medical equipment from reaching the United States as quickly and as cheaply as possible.
This effort should resemble the U.S. effort to ramp up production of materiel to defeat the Axis powers during World War II.
In spirit, this effort should resemble the U.S. effort to ramp up production of materiel to defeat the Axis powers during World War II. In practice, the government spending and transfers to companies and local governments will be modest, at least relative to the World War II effort. Done properly, investment in stopping the virus and developing a vaccine will likely run into the tens of billions of dollars—spending that will increase the United States’ stock of scientific knowledge and boost private-sector productivity down the road.
In addition to limiting the duration of social-distancing interventions and the economic damage they cause, this investment will help restore public trust and confidence in government. One reason that faith in civic leaders has eroded in recent decades is that Americans increasingly see government as incapable of fixing communal problems without graft and corruption. A large, visible, and successful government effort to stop the coronavirus would help rebuild trust.
Once the coronavirus has been contained and social-distancing measures are no longer needed, the U.S. government should move quickly to support businesses hurt by plummeting household demand. That will include restaurants and bars, sports teams, airlines, and many other businesses whose collapsed revenue streams have left them unable to pay workers, suppliers, and landlords. Without a mechanism to share the collective economic costs of flattening the curve, the burden of social distancing will be borne by these businesses alone.
The federal government should thus make large transfer payments to businesses (on the condition that those businesses maintain their pre-crisis payrolls) in order to make up for falling demand. It should finance these transfers through deficit spending, borrowing a large amount of money now and paying it back later with tax revenues. The economists Emmanuel Saez and Gabriel Zucman have proposed a similar fiscal-backstop idea, calling on the government to act as a “buyer of last resort.” Such a backstop should not consist of loans. No matter how generous their terms, loans from the Federal Reserve or any other lender would need to be paid back eventually, meaning that they could never make up for lost business revenue. Fiscal transfers would not need to be paid back.
The biggest obstacle to these transfers is the cost.
Such a backstop should not be thought of as a bailout. Bailouts connote unwarranted forgiveness for errors that could have been avoided with greater prudence. Millions of U.S. businesses could not reasonably have foreseen not just the possibility that a global pandemic would hit their sectors but that a health policy response would decimate their revenues. We see little risk that transfer payments will invite businesses to engage in irresponsible behavior in anticipation of support during future pandemics.
Transfer payments to businesses would also be more effective than direct transfer payments to under- and unemployed workers and their families after struggling businesses have let these workers go. Payments to businesses would prevent layoffs from happening in the first place, preempting the economic and personal disruptions that come along with involuntary job separations. Workers already laid off would continue to receive unemployment insurance benefits, but those whose employers receive transfers would be reinstated on the payroll. These transfers would also prevent unnecessary damage to perhaps millions of businesses that were otherwise sound but for this historic shock to their finances.
Such a program would of course present administrative challenges. The government would have to identify which industries have been sufficiently damaged by the coronavirus pandemic to merit support. It might be simplest to start with the obvious cases, such as sectors in which the government has compelled a shutdown. Authorities would then need to decide exactly how much lost revenue to offset. To provide maximum risk sharing, we suggest offsetting 100 percent of lost revenue compared to some pre-crisis period, which would mean that the government absorbs all of the loss. Finally, the transfers would take time: time to write, debate, and pass legislation and even more time for the relevant federal agencies to actually make the transfers to what will likely be millions of businesses. Our hope is that the speed with which a Coronavirus Depression is approaching will focus the minds of U.S. government leaders as never before.
But by far the biggest obstacle to these transfers is the cost. The backstop would unfortunately need to be so large that it would materially darken America’s fiscal future. The ultimate cost would depend on the length of time needed to flatten the curve—and thus on the success of the government’s initial efforts to halt the spread of the virus. Assuming it takes six months of aggressive public health restrictions to flatten the curve, the above analysis indicates that the hit to consumption demand will be between $1 trillion and $2 trillion—all of which the government would have to make up in the form of transfer payments to businesses.
The United States’ fiscal future is already sobering.
This additional federal spending would come at a time when the U.S. government is already running trillion-dollar deficits. The Congressional Budget Office reports that the 2019 fiscal deficit was $984 billion, and it forecasts a 2020 fiscal deficit of $1.02 trillion. Backstopping businesses hit by the coronavirus could double or triple the size of that deficit.
We don’t know exactly what impact this dramatic expansion in federal borrowing would have on U.S. interest rates. And we acknowledge that the United States’ fiscal future is already sobering, with rising national indebtedness a near certainty given the country’s aging population and rising health-care costs. But the alternative to backstopping businesses is not a stable fiscal deficit. It is a widening deficit as businesses fail and tax revenues plummet.
The United States has relied on deficit spending during previous periods of crisis, including World War II. Rather than force those alive and paying taxes during the war to bear the full burden of increased wartime spending, the U.S. government instead issued record amounts of Treasury debt that it paid down gradually over many years. The federal deficit increased from about three percent in 1940 to 27.5 percent in 1943, while total outstanding U.S. federal debt as a share of GDP rose from about 44.5 percent in 1941 to a staggering 119.1 percent in 1946. In subsequent decades, fiscal surpluses (or sufficiently small deficits relative to economic growth) brought those figures down. In that way, the U.S. government shared the cost of World War II with future generations. It should do the same in the fight against the coronavirus.
The first two steps that the United States should take to head off a potential Coronavirus Depression are mainly actions of fiscal policy and thus the purview of Congress and the presidency. The third step falls mainly to the Federal Reserve—the United States’ central bank—and to those portions of the executive branch that regulate capital markets, such as the U.S. Department of the Treasury. Step three is prescriptive and aspirational: remaining vigilant and creative—in particular by providing new lending facilities as needed—so that the damage to the real economy does not infect financial markets and cause a crisis there.
Many of the deepest recessions in history, such as the Great Recession of 2008–9 and the Great Depression that began in 1929, originated with trouble in the financial system that radiated outward to businesses and households. As noted above, the economic damage caused by the coronavirus started not in capital markets but rather on Main Street, with consumers being unable to make their usual purchases. Nevertheless, the collapse in consumption demand could harm capital markets if businesses are unable to pay their debts. It is difficult to predict how markets would react to such a situation, but their basic functions—channeling savings into investment opportunities and managing risk—could be impaired. And if banks are forced to absorb waves of simultaneous repayment difficulties (or outright defaults) from millions of businesses and tens of millions of individuals, it is unclear what would happen.
The economic damage caused by the coronavirus started not in capital markets but rather on Main Street.
In recent weeks, stresses have already appeared in multiple parts of U.S. and global capital markets. For example, despite dramatic cuts to interest rates by the Fed, U.S. mortgage rates have risen rather than fallen—the opposite of what usually happens. Central banks and other regulators need to remain vigilant and creative to keep pricing and trading as steady as possible in U.S. capital markets, even while pressure mounts as millions of businesses struggle—and in many cases fail—to pay their creditors. Already, many central banks—including the Fed, the Bank of England, and the European Central Bank—have moved to blunt the damage done by the coronavirus by slashing interest rates and announcing new bond-buying plans. But because the source of the economic trouble doesn’t lie in financial markets, there is only so much these central banks can do with monetary policy. For that reason, the U.S. government must move aggressively with fiscal policy to halt the spread of the virus and to backstop businesses. The more successful the administration and Congress are in steps one and two, the less the Fed and other regulators will need to do in step three.
NO TIME TO WAIT
The coronavirus pandemic need not cause an economic loss of historic proportions. But the window of opportunity to prevent a severe recession or even a depression is closing fast. The economic damage is already starting to appear in leading indicators such as rising claims for unemployment benefits and in forward-looking indicators such as falling stock prices that foretell lower business earnings. Every day that passes, businesses lose billions of dollars. And since the start of the crisis, trillions of dollars have disappeared from employee retirement accounts. The time for leaders to respond is now.
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