As parts of Europe face a second wave of the Covid-19 virus on a large scale, it is timely to consider what makes an appropriate fiscal response. In the advanced economies, governments are throwing money at the problem in the hope that their borrowing costs will remain low for longer.
We may rightly conclude on the basis of its new inflation targeting measure that the Federal Reserve will not raise its benchmark rate before 2023 at the earliest but we should be looking for comfort for at least another decade down the road, given the spending binges this year.
To date, the additional fiscal stimulus in response to the virus in Japan has been 21.0 percent of GDP, compared with 2.2 percent in response to the global financial crisis in 2008; for the UK, the figures are 14.5 percent and 1.5 percent; for the US, 12.1 percent and 4.9 percent; for India, 10.0 percent and 0.5 percent; for South Africa, 8.6 percent and 2.9 percent; and for Brazil, 5.5 percent and 0.6 percent.
These figures from a reputable source may well be further increased. Last week Jerome Powell, chair of the Fed, said that the US recovery from the virus could be jeopardised if Congress failed to approve a new fiscal package. As we approach a hotly contested US presidential election, such a bipartisan agreement looks unlikely.
Elected politicians and policymakers are tempted by the idea that they can spend their way out of the crisis: they want to be popular and they want to be re-elected. Where there are no elections or they are not genuinely contested, the pressure is off the government.
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Because we are in uncharted waters, there is no right or wrong way to channel public money. We are all groping in the dark. When we faced lockdown in various forms in March/April (except in China), media commentators liked to say that government X had the best approach. It was too early to say then (because we now face a second wave) and it is too early now to pick government Y as making best use of public resources.
Under pressure from the political opposition and the media, governments rushed to provide loans to small businesses. We hope that we are off the mark but fear that the bill for loans turned sour because of market conditions or fraud will be substantial
Governments can pay the salaries of private-sector employees, they can guarantee loans to selected companies or industries, and they can freeze or defer taxes. At some point, the rug must be pulled and the benefits withdrawn.
Unemployment then rises or soars, depending on how many of the rescued firms prove to be zombie operations. Governments are not best placed to make this call because their skills tend not to include running a successful business. Ministers with this proven expertise are in a small minority in governments. Those who have worked in the private sector tend to have served in household names in investment banks or in management consultancy. (Nigeria is covered by this generalisation.)
Under pressure from the political opposition and the media, governments rushed to provide loans to small businesses. We hope that we are off the mark but fear that the bill for loans turned sour because of market conditions or fraud will be substantial. We see the bold talk from governments that they will recover funds from criminals as delusional. Credit checks under many schemes in operation were minimal, such was the hurry.
A harsher line would have been for governments to offer a smaller fiscal stimulus, and accept a quicker and larger increase in the bill for unemployment and other social benefits. The bill in question is far smaller in developing countries but a fiscal response for all jurisdictions is a programme of public works. As a result of climate change (negative) and the continuing IT revolution (positive), there is plenty of work to be done in advanced economies.
It is too soon to call out the winning fiscal approach, as we have indicated. Our hunch is that governments in developed economies overreacted under pressure when they opened their wallets and are likely to repeat the mistake in the face of the second wave.
To quote Mario Draghi, the last president of the ECB, out of context, elected governments are seemingly minded to spend “whatever it takes” to overcome the virus, and its impact. Public debt in many developed jurisdictions is approaching 150 percent of GDP or more. Whenever inflation takes off and monetary authorities finally respond with tightening, the chickens finally come home to roost.
There is another approach to mitigate the blow to the public finances but governments are reluctant to take it. This is a generational shift in wealth that would soften the legacy for today’s young. It could be presented as a non-discriminatory property or pension tax, for example, that would help to free future generations from the fiscal straitjacket that threatens to stifle our economies for years to come. Because most elected governments are conservative in outlook and draw their support disproportionately from older voters (ourselves included), they are unlikely to buy into this approach.
Gregory Kronsten is the Head, Macroeconomic and fixed income research at FBNQuest Capital
