The most crucial government priority in the COVIRUS-19 pandemic is aggressively fostering the development of effective vaccines and therapeutic treatments. While stabilization policy-making does not directly contribute to the key objective, well-designed action on the macroeconomic front is critical to containing the welfare costs of the variegated social efforts which suppress the spread of the novel coronavirus. The GEM Project has identified four stabilization-policy priorities in the pandemic.
Macroeconomic Policy Priorities
The interrelated stabilization objectives most critical in the extraordinary circumstances of the pandemic are:
- The U.S. Treasury should replace wage income lost to the Pandemic.
- Deep-pocket public subsidies should further be used to prevent business bankruptcies in response to the pandemic.
- Stabilization authorities – the Federal Reserve, the Congress and the Executive Branch – should adhere to the principal lessons learned in 2008-09. Go big and go fast.
- All of the additional federal debt resulting from the massive government efforts to mitigate the human and economic cost of COVID-19 should be purchased and held by the Fed.
GEM modeling indicates that those objectives, if successfully pursued, would effectively manage pandemic stabilization risks. Consider each in turn.
First, replacement of wage income is a no-brainer. It is both ethical and provides a good deal of the support for aggregate spending sufficient to stabilize the economy.
Second, mass liquidity bankruptcies would grievously damage lifetime financial paths of millions of people as well as disastrously forcing recovery dynamics to accommodate the painfully slow, painfully arrogant justice system’s liquidation processes. In circumstances of extreme instability, debt dominos do double duty. The immediate effect is to substantially aggravate the collapse of total nominal spending. Subsequently, the resumption of growth is badly hindered, similar to the drag experienced in the aftermath of the Great Recession, by the extent to which bankruptcies and associated debt problems are slow to be resolved.
How well we achieve the bankruptcy-prevention objective will greatly influence the course of the post-vaccine economy. At the onset of the pandemic, fiscal and monetary policymakers assigned high priority to income replacement and bankruptcy prevention. They must not lose that focus in the remainder of the pre-vaccine period.
Third, the U.S. central bank can create money. In the circumstances of extreme instability threatening depression, that is a super power. The GEM Project has identified the Fed’s crucial responsibility to prevent a breakdown of the financial system’s capacity to support aggregate demand in circumstances of nonstationary contractions of total spending.
The fourth priority is particularly relevant in a pandemic. If successfully pursued, it avoids trillions of dollars of federal debt being sold to domestic or, worse, foreign investors. The structural risks that the proposed Fed buy-and-hold strategy would be dealing with include, at the most benign, the eventual crowding out of important safety-net, other social-service, and defense spending.
More on the Fed
Why does GEM modeling of the pandemic pay so much attention on the Federal Reserve? As already noted, it has the unique authority to create money. It is crucial to understand how best to use that super power.
Go big; go fast. March 16 was the day the virus attempted to break the financial markets. But the Fed had seen collapsing asset prices before. The 2008-09 playbook is very much in place at the central bank. This Fed has aggressively, and courageously, followed it. Jerome Powell has proven himself to be a worthy successor to Ben Bernanke.
Purchase of the COVID-19 federal debt. At the more extreme end of the eventual damage that could be caused by the huge pandemic-related increase in Treasury borrowing are a U.S. sovereign credit crisis and/or a debilitating period of high product-price inflation. Rapid inflation is also the argument used against the central bank buying and holding Treasury debt. The GEM Project provides by far the best model of price-inflation in the macro literature. It demonstrates that the Fed can take advantage of the huge pandemic reduction of capacity utilization to buy and hold the virus-related paper without inducing damaging price inflation. The key stabilization problem today is too little, not too much, total spending.
Moreover, currently low interest rates cannot be relied on to neutralize the new debt’s capacity to induce credit crises. This is especially true as the maturities of the new paper are shortened, making it easier to sell. But, even if relying on 30-year bonds to fund the Treasury’s entire pandemic deficit were feasible, such sales would require interest rates greater than the demographically challenged trend GDP growth rate – the principal indicator of unstable debt dynamics.
Biggest Likely Policymaker Failure
Based on personal experience, especially during the 2008-09 extreme instability that also significantly threatened depression, I believe that today’s greatest risk to the policy priorities listed above is the failure of fiscal policymakers to do their part. History indicates that Congress quickly loses its focus even when confronting big problems, reverting to a more comfortable state of political in-fighting that typically derails concerted action. Congress’s lack of focus on what was important during the Great Recession was dangerous and embarrassing, forcing the nation to rely almost wholly on the Federal Reserve to avoid depression.
It is an ominous sign that Washington politicians appear to be shifting back to most worrying about political advantage. That shift was evident before today’s news about rebounding employment in May. Given that jobs jump is largely an artifact of the distribution conditions governing the trillions of dollars in COVID-19 relief, the best bet is the successful pursuit of near-term stability will be significantly helped by at least one more large tranche of income replacement. It will certainly not be helpful for Congress to prematurely return to its familiar self-interested, destructive behavior. It is already clear that the President has lost interest in any policy action, however promising, not targeted on rapidly improving capacity utilization prior to the November election.
Blog Type: Policy/Topical Saint Joseph, Michigan