With governments across the world scrambling to announce massive fiscal support packages to offset the economic damage caused by policies to contain the coronavirus outbreak, I thought it was a good time to answer some of the questions we’re getting from clients.
Why is the focus on fiscal rather than monetary policy?
The theory is that government giveaways could be useful if the economic shock proves short-lived. A bit like a payday loan, we might just need to get through the next few weeks and then we’ll be alright.
However, perhaps more importantly, monetary policy is very low on ammunition: an average post-war recession has seen roughly 400bp of short-dated rate cuts, but today’s interest rates entered the crisis too low to make much of a difference.
There’s always quantitative easing. But the European Central Bank and the Bank of Japan were already doing it; and while the most important central bank in the world, the Federal Reserve, has decided to restart its asset-buying programme, the Fed is restricted to government and mortgage bonds rather than riskier assets.
What is fiscal policy trying to target?
There’s a near-term and a long-term outlook here. More traditional forms of fiscal easing like infrastructure spending or VAT cuts might be used to help the recovery once we’re through the worst. But it’s the near-term outlook that’s the main concern, given economic activity is screeching to a halt across many countries and sectors.
Here we’re looking at personal solvency – how do we make sure people can pay their mortgage or rent, and keep up with credit card and auto loan repayments? And corporate solvency – helping companies survive the dramatic downturn and maintain employment.
What short-term measures do we expect?
There are a few choices. On the personal side, we could see a simple transfer of money to everyone, like Hong Kong has done. But this seems rather wasteful as lots of people don’t really need the money and might just save it. Instead, more generous unemployment benefits would support the gig economy. For the traditional workforce, governments could help pay wages. This sort of policy is already in place in Germany and we’ve seen similar announcements from New Zealand.
For corporates, there needs to be help with cash flow. Things like tax deferrals, lower business rates and the labour cost measures already mentioned could really help. Loan guarantees are also useful. A number of governments have already unveiled such measures, most recently the UK government on Tuesday.
It remains to be seen what the ultimate fiscal costs will be, but these steps can help shore up confidence and prevent a damaging cycle of defaults.
We think banks will naturally support profitable businesses if they think the problems are temporary – bank balance sheets have improved in recent years and central banks are providing ample liquidity. But weak businesses, already on the ropes, might still be forced to close because their equity holders choose to file for bankruptcy anyway.
Unfortunately, there is little monetary or fiscal policy can do to support such businesses, and this is why it is very hard to avoid an economic contraction now.
How can central banks help with fiscal policy?
In some ways, monetary policy can complement fiscal support. For example, buying corporate bonds via QE helps to cap the market yield for financing and frees up investor firepower to lend to companies. Central banks can also lend to the private sector through various credit facilities, but they will need credit protection from the fiscal authorities.
More dramatically, central banks could choose to cap government bond yields across the curve, promising to buy unlimited government debt above a certain level. Indeed, the Bank of Japan has been doing this for a number of years. Such a measure would reduce the funding costs of fiscal hand outs.
Are there any side effects?
Unfortunately, fiscal generosity is not a risk-free solution. It’s going to be very difficult to know how much support is needed, so the chances are that governments will throw money at the problem until they see positive results.
Once the dust settles, such extraordinarily fiscal hand outs and central bank support will probably have side effects – for example, we could start to see inflation accelerating to uncomfortable levels. Very weak countries that borrow in foreign currencies to fund their policy could even get into solvency difficulties. But right now, it’s all about trying to solve today’s issues.