Covid-19: The Unintended Consequences Of The Policy Response
(this article originally appeared in Forbes)
The interplay of economics and public health represents the defining feature of the Covid-19 crisis. Any initial resistance to a total lockdown, and later any support for reopening business activity, has been painted in some quarters as a choice between profits and lives. More thoughtful commentators have noted that both a deep recession and the lockdown itself will cost lives: suicides, drug abuse, domestic violence, and the serious ailments that go untreated while we focus exclusively on Covid-19.
There is another dimension in which the economic debate has been shaping our response to the virus, however, one that has been much less noticed and discussed. Yet it is especially important because it will influence our long-term strategy against a public health challenge that might prove long-lived.
The economic policy response to the Covid-19 recession carries costs and risks of its own. Yet the public debate has focused almost entirely on how effective this policy response will be—whether it can deliver a V-shaped recovery, or at least a U-shaped one—and not at all on its long-term consequences.
This is the perilous consequence of a debate that has been brewing in academic and policy circles for the past decade and has generated a growing consensus around the concepts of “secular stagnation” and “new normal”. In a nutshell, this school of thought holds that the world suffers from a structural shortage of investment and consumption and a corresponding excess of savings; this results in perennially low interest rates and anemic economic growth. The only way out, as former US Treasury Secretary Larry Summers has argued, is a major increase in government spending, preferably on public investment; since interest rates are—and will remain—extremely low, this spending boost can be financed with a large increase in public debt at minimal cost.
A twin argument adds that we can aid and abet greater fiscal spending with another major expansion in monetary policy, where central banks like the Fed and the Bank of England purchase increasing amounts of government bonds, corporate bonds and other financial assets while pumping new liquidity into the financial system. This, its proponents argue, will have no adverse consequences: in a world of secular stagnation inflation will remain dormant; and macro-prudential regulations safeguard us from any risk to the financial system.
An extreme version of this view, Modern Monetary Theory (MMT), has enjoyed a resurgence in popularity. MMT claims a government that issues its own currency does not face a budget constraint: it can run up debt without limits, because it can always repay it by printing money. The only constraint kicks in if inflation starts rising, but MMT aligns with Secular Stagnation to claim this will never happen in our lifetimes.
A number of voices credit the advocates of MMT and secular stagnation for enabling the needed massive policy response to this crisis. Without their intellectual firepower, they say, policymakers would have been hamstrung by misguided concerns about the dangers of looser fiscal and monetary policy. Politicians like Jeremy Corbyn in the UK and Alexandria Ocasio-Cortez in the US have felt vindicated and have argued that the “let’s-pull-all-stops” economic policy reaction to the crisis proves they were right all along in arguing that governments can and should massively expand public spending.
This all adds up to a rather seductive view of the world, one where we face virtually no limit to how much money governments and central banks can create and spend. It’s a dangerous view, which poses three major risks.
The first is that if we underestimate the costs and risks of the economic policy response, we will underestimate those of the lockdown. The temptation to prolong—or reinstate—extreme social distancing and restrictions to business activity will be that much stronger if we believe governments and central banks can costlessly alleviate the adverse consequences.
The second is that these ideas will oil the already slippery slope towards much greater government intervention in the economy. A world where more and more households and businesses depend on the government for benefits, subsidies and concessional loans becomes a lot more plausible if governments believe they have unlimited firepower. And as a prolonged lockdown exacerbates income inequality, because it hits disproportionately workers with lower skills and wages, the pressure for more government intervention will gather steam.
The third is that once a large share of the population becomes dependent on the government, this will generate its own quicksand dynamics. The temptation to have a large client base of voters dependent on government largesse might prove irresistible for politicians; for individuals, such a situation would kill initiative and entrepreneurial drive, undermining innovation and growth. As the weeks tick by, and more and more businesses drift helpless into bankruptcy and millions of people face long term unemployment, this becomes a real and present danger.
Pulling ourselves out of the covid-19 recession will be hard; it will require redoubling our efforts on private investment and innovation. Governments will play an important role—but it will need to be a smarter and more efficient role, not one centered on a larger presence in the economy.
The comforting message of MMT and secular stagnation advocates might make it easier for some policymakers to believe that the lockdowns can be extended far into the future with limited lasting damage. That would be a terrible mistake, and it would lead to a very unpleasant reality check. Bloated central banks’ balance sheets will cause unpredictable dislocations in financial markets. Massive increases in public debt levels will need to be repaid through higher taxes or stronger economic growth. And stronger sustained economic growth cannot be generated through government spending alone; central banks cannot print prosperity.
Unfashionable as this view might now be, we need to recognize that there is no free lunch. We need to build a strategy to safely get our economies back on their feet as quickly as possible, and then focus on policies to boost productivity to accelerate economic growth. Otherwise, no amount of fiscal and monetary policy support will save from a painful prolonged curtailment in living standards.