I am still trying to wrap my head around the coronavirus disaster. Here is some current thinking . . . The immediate cause of the economic slowdown is a collapse in both demand and supply due to social isolation. This will have at least two knock-on effects. First, the initial collapse in economic activity will be magnified by a traditional demand multiplier effect. Second, the collapse in economic activity will lead to widespread formal and informal bankruptcies as unemployed workers are unable to pay rent, mortgages, car payments, etc., and businesses and non-profit institutions are unable to service their debts or cover their fixed costs. These bankruptcies could trigger a financial crisis as banks and other financial intermediaries end up with
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I am still trying to wrap my head around the coronavirus disaster. Here is some current thinking . . .
The immediate cause of the economic slowdown is a collapse in both demand and supply due to social isolation. This will have at least two knock-on effects. First, the initial collapse in economic activity will be magnified by a traditional demand multiplier effect. Second, the collapse in economic activity will lead to widespread formal and informal bankruptcies as unemployed workers are unable to pay rent, mortgages, car payments, etc., and businesses and non-profit institutions are unable to service their debts or cover their fixed costs. These bankruptcies could trigger a financial crisis as banks and other financial intermediaries end up with non-performing assets. In addition, if nothing is done to prevent it, widespread bankruptcies and capital depletion will damage or destroy many otherwise viable businesses and critical non-profit institutions, including schools and hospitals. Of course, demand will eventually return, but there may be large costs of redeploying capital and labor to new firms and institutions.
So, what can we do to avoid an economic disaster, assuming the epidemic does not end quickly?
Sending checks to all Americans seems to be emerging as the leading policy idea as Congress ponders its next response to the emerging economic crisis.
Sending checks to all Americans has a certain political appeal, but it is shockingly bad economics. The majority of households are still working and voluntarily spending less, so most of the money sent out in checks will be saved, not spent. This means that there will be little increase in aggregate demand, and also very little reduction in formal and informal bankruptcies. On the other side of the ledger, the amount of money sent to families that really need help – and will increase their spending and payments to creditors – will be woefully inadequate.
A much better approach is to get cash into the hands of unemployed workers and their families. There are various ways to do this, but an obvious approach would be to have the federal government pay to increase and extend unemployment benefits so that low- and middle-income families do not end up cutting back on their consumption or defaulting on their debts or contractual obligations (leases, etc.). House Democrats may have an opportunity to refocus the conversation on unemployment compensation next week when the unemployment claims figures – which will be truly frightening – are released.
Paid sick leave would reduce transmission of the virus; it would also help maintain demand and alleviate hardship. In my view it should be temporary and paid for by the government. We need to get something through Congress now, we can fight to expand the safety net later. Democrats have made only limited progress on paid leave so far, but perhaps they can leverage growing concern to get a better program through.
Dealing with the cascading insolvencies that social isolation will cause is a much more difficult problem. Even if unemployment insurance and sick leave cushion most families, the damage done to large and small businesses and especially to non-profit institutions (that have no natural way to recapitalize after a crisis) could be immense. There are no easy answers here, but a few thoughts:
I am skeptical of plans to lend money to businesses that agree to maintain employment (see Andrew Ross Sorkin here). People have been laid off because demand for goods and services has collapsed or because it is not safe for them to go to work. Most businesses would simply refuse to participate in a program that allows them to borrow money if they are required to pay workers for not working. (Essentially, a firm that takes on a loan to avert a short-term cash-flow bankruptcy and gives most of the money to workers who are not producing revenue will end up insolvent in a balance-sheet sense. Firms that are viable in the long run but cash constrained in the short run would be better off filing for bankruptcy and paying off their creditors when demand increases than avoiding bankruptcy by using government loans to pay their workers for not working and then having all that additional debt to pay off when conditions improve.)
Of course, we could give money to businesses that agree to maintain employment, as Saez and Zucman propose, but instead of using businesses as conduits for money from the government to laid-off workers, but why not just give workers generous unemployment benefits? This has the huge advantage of being a system that actually exists. And I am not sure why business losses should be socialized, as Saez and Zucman propose, although serious consideration should be given to supporting and ultimately recapitalizing non-profit institutions.
I am sympathetic to Dean Baker’s view that shareholders should take substantial losses when large companies need to be recapitalized by the government. We don’t need more socialism for the rich in this country. However, I doubt that the government can take an equity position in hundreds of thousands of small and mid-sized businesses. My guess is that this means either going the Saez Zucman route or making it much easier for households and firms that are cash-constrained to get bankruptcy protection. Bankruptcy is not my area and I’m not sure what proposals are out there, but see Levitan here and Lawless here for some thoughts.
Finally, let me reiterate the point I made yesterday. Social isolation is not a sustainable policy. It will destroy our economy, our social and cultural institutions, and potentially our democracy. Mass testing – the ability to test almost everyone in an afflicted area, not just those who have symptoms or known contacts with an infected person – is the only tool we have that can reliably end this crisis if the pandemic does not subside naturally. The Trump administration’s handling of testing has been a scandal, but Congress also needs to do more. Congress should establish aggressive goals for testing capacity that go far beyond the 100,000 or so daily tests that would make us comparable to South Korea on a per capita basis, and it needs to provide much more funding than it has so far. If Congress truly believes this pandemic is an existential threat, this should be at the top of their to do list.