At a time of crisis, economic policymakers are well-advised to hope for the best but to plan for the worst. This advice could not be more apt now at a time when the coronavirus epidemic seriously threatens the U.S. and global economic recoveries.
Unfortunately, judging by President Trump’s most recent pronouncements, it would seem that the U.S. Administration is still hoping that the coronavirus epidemic will prove to be short-lived and to have limited economic effects. Never mind that there is now the clearest of evidence that the epidemic is spreading at a rapid pace around the globe, including in the United States. Never mind too that it is wreaking havoc in the US and world’s equity markets.
The truth of the matter is that the coronavirus epidemic is simultaneously dealing the global and U.S. economies with a supply shock, a demand shock, and a financial market shock.
The supply shock is coming in the form of quarantining millions of workers, most notably in China and Italy, disrupting international supply chains, and dislocating transport systems. The demand shock is coming as a result of heightened household and investor anxiety about the economic outlook that causes them to delay their spending.
Meanwhile, the financial market shock is coming in the form of sharp declines in global stock market prices on the back of diminished corporate earnings expectations. It is also coming in the form of a sharp rise in corporate borrowing costs as investors dial back on their risk tolerance for fear of rising default rates.
Unfortunately, there is not much that economic policymakers can do to deal with the coronavirus supply shock. Interest rate cuts or a fiscal stimulus is not going to prevent the Chinese and Italian government’s decision to confine citizens to their homes from decimating Chinese and Italian industrial production.
While there might be little that economic policymakers can do to prevent the coronavirus supply shock from impacting their economies, there is in principle much that they can do to prevent that supply shock from leading to an undue contraction in demand and from creating a doom loop in the financial markets.
The trouble though is that economic policymakers are running out of traditional policy instruments to support demand and to calm financial markets. The Federal Reserve’s policy rate is already down to around 1 percent leaving little room for further interest rate cuts. Meanwhile, as a result of the 2017 corporate tax cut, the U.S. budget deficit has ballooned to 5 percent of GDP for as far as the eye can see, which limits the scope for fiscal policy stimulus measures.
In these circumstances, it would not be too early for economic policymakers to be thinking outside of the box as to what else they might do to support demand and calm the financial markets. In this context, they might do well to devise plans to prevent credit markets from seizing up and to revisit Milton Friedman’s idea of helicopter money. The basic idea of helicopter money would be to have the Federal Reserve finance on the easiest of terms government cash handouts to that part of the public most likely to spend that handout.
At a time of a global economic crisis, it is most effective if bipartisan support is built for bold U.S. economic policy action and if the world’s policymakers coordinate their economic policy response. Lacking a bipartisan approach and lacking international leadership from the Trump administration, I am not holding my breath for this to happen.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging-market economic strategist at Salomon Smith Barney.