Jay ShambaughMonday, March 23, 2020
An aggressive response aimed at improving the availability of testing, equipment, emergency supplies, hospital capacity, and treatment is paramount for public health and the well-being of Americans. In addition, as long as there is a widespread outbreak and rapid transmission, economic activity will be curtailed. Therefore, the crucial actions taken to limit the spread of the pandemic will have the greatest impact for both the broader welfare and the economy.
This document offers answers to frequently asked questions about the impact of the COVID-19 pandemic on the U.S. economy and the implementation of various fiscal and monetary policy tools used in response to the crisis. While the document focuses on the economic policy tools used to respond, it is important to remember that the most crucial steps both for overall welfare and for the economy will be those taken to limit the spread of the pandemic itself. As long as there is a widespread outbreak and rapid transmission, economic activity will be curtailed.
Q: Has the COVID-19 pandemic caused a recession in the U.S. economy?
A: The U.S. economy has almost certainly entered a contraction.
Unemployment insurance claims reported for the week ending March 14th showed a sizable spike, but the true contraction likely started the following week (the week ending March 21st). It appears that millions of Americans have already lost their jobs, likely at a pace that exceeds job losses in the worst weeks of the Great Recession. Even if economic activity in the United States were not being shut down in support of social distancing, the current spread of the COVID-19 pandemic around the world reduces demand in the world economy and complicates supply chains, and the drop in equity prices lowers household wealth to an extent that would have caused a sizable slowdown in the U.S. economy. When those factors are added to the economic disruption needed to fight the virus, the United States will likely see one of the sharpest economic contractions in its history this March, continuing through the second quarter of 2020. The open question will be how quickly restrictions on activity are lifted and whether the economy can snap back; both will depend in part on policy responses.
Q: Why aren’t the Federal Reserve’s monetary policy tools sufficient to sustain the economy? Why must we also rely on Congress to enact fiscal policy?
A: The core problem the economy faces is not a lack of liquidity, but a temporary halt of activity due to health restrictions and a fundamental question of solvency for many firms and individuals. Thus, the activities of the Federal Reserve are important, but unlikely to be sufficient.
In many economic slowdowns, the Federal Reserve is the front line of defense. In this case, it has already lowered interest rates to zero and begun sizable purchases of assets along with injections of liquidity into financial markets. These actions are important, but unlikely to shield the economy from widespread damage. First, the shutting of businesses and limits on travel will cause economic activity to contract regardless of policy. Second, as the Federal Reserve has already lowered rates to zero, it is out of conventional ammunition to stimulate the economy, leaving it to use alternate tools like asset purchases or forward guidance. The Federal Reserve typically stimulates the economy by making it easier and less expensive to borrow, encouraging firms and consumers to accelerate investment and purchasing decisions. In this case, the uncertainty about the eventual outcomes of the COVID-19 pandemic and the economic fallout may make it very difficult for firms to borrow regardless of rates (the credit risk may keep banks from lending), and more importantly, the option value of waiting to see the resolution of the pandemic will likely slow any investment or major purchase decisions.
Q: How can fiscal policy help the economy?
A: The primary goal for fiscal policy at present should be to cushion the downward shock as much as possible and set the conditions for the economy to bounce back after the restrictions on economic activity are removed. Over time, fiscal policy can be used to try to help restart the economy.
Beyond spending on the crisis itself, there are a number of important roles for fiscal policy. While discussions at present refer to stimulus, in some ways it is the wrong term currently. The economy is being shuttered to allow for social distancing and to stop the virus. First, federal fiscal policy can strengthen the safety net to make sure anyone losing a job or with limited resources can get through the next few months. The expansion of paid sick leave benefits to a wider (though still limited) set of the population could be an important economic cushion and a way to slow the spread of the virus. In addition, the government can distribute funds directly to households to ensure that families have a financial cushion and that there is adequate purchasing power in the economy as households weather social distancing and when restrictions are lifted. Fiscal policy can be used to guarantee loans and/or provide direct support to firms that are in trouble to prevent systemic problems in order to maintain their payrolls. Finally, the federal government can provide financial support to states. States have limited capacity to borrow, and when their costs go up (due to health and public safety measures) but revenues go down (due to lower tax returns), they are often forced to cut spending. Federal support can shore up state spending, especially as states are on the front lines of the public health crisis. Over time, the emphasis of fiscal policy should shift toward increasing spending and resources in the economy to restart economic activity.
Q: How big should a fiscal package be?
A: The fiscal policy package should be large enough to address immediate needs and persist over the longer-term through public-health-based and economic-condition-based triggers.
At present, fiscal policy responses are primarily aimed at cushioning the blow to households, states, and firms. That alone will likely require the largest single fiscal policy package ever (likely well in excess of a trillion dollars, but potential need is possibly much larger). One way to scope a plan appropriately would be to pass everything that is clearly needed now and allow subsequent payments (to households, states, and firms) to vary with health and economic conditions over time. Such an open-ended commitment could be massive, but if appropriate triggers for later spending are put in place, and those thresholds of economic or health distress are crossed, then it would be appropriate to have such a large package. Throughout the month of March, any potential response mentioned has seemed too small a week later. As such, it would make sense to begin with a very large package and allow for continual fiscal activity if conditions warrant. While the budgetary impact may be substantial, at present, the United States government borrows at historically low rates. Markets do not doubt U.S. government solvency, and any longer-run budget concerns should be addressed after the current crisis is past.
Q: Why does the federal government need to help states’ finances?
A: Substantial support for states from the federal government can alleviate budgetary pressures from increased spending on public health, unemployment, as well as reductions in consumption-based revenue. Such budget help would give states the resources they need to fight the pandemic and also make it less likely that states act as a brake on economic activity going forward.
States are on the front lines of the pandemic. Protecting their citizens will raise public safety and public health expenditures. Making sure states have adequate resources to fight the downturn is a crucial part of a public health response. Legislation in mid-March provided states with more funding by increasing the federal share of Medicaid spending. Certainly, more help will be needed both for acute issues (purchasing medical equipment, funding hospitals and health centers) and longer-term medical costs. An additional increase in the federal share of Medicaid as well as grants of unrestricted funds to make sure states and localities can continue to meet their obligations for health and public safety are necessary. Furthermore, the coming wave of unemployment will put pressure on state unemployment insurance trust funds, and they will almost certainly require support. At the same time, a decrease in economic activity means lower tax revenues for states. States generally cannot borrow for current operations, forcing them to either raise taxes or cut spending when a downturn worsens their budget outlook in the short term. This can have spillover impacts on the economy, limiting the potential for the economy to grow after the health restrictions are lifted.
Q: What role can safety net programs (such as UI, SNAP, WIC, etc.) play in reducing the impact of an economic downturn?
A: The safety net in the United States is one of the most important fiscal automatic stabilizers we have. As economic conditions deteriorate, spending rises on Unemployment Insurance (UI) and SNAP (formerly known as the Food Stamp Program), pushing billions of dollars into the economy. A sizable advantage of these programs is that they are well-targeted to households and regions that need the help most, and they put resources in the hands of people highly likely to spend due to liquidity constraints. In addition, because these programs already exist, they can get money to households quickly compared to creating new programs.
At the same time, the safety net can be used more effectively. UI can be challenging to access including waiting periods, administrative burdens, and search rules. All should be eased at this time. Further, UI does not replace all lost wages in order to provide an incentive to find work. In the current crisis, as no work is available or even imminently available, raising UI payments would be an administratively easy way to get more money to people quickly. Finally, roughly half of U.S. states allow UI to be used as part of work sharing (if a firm cuts workers’ hours instead of employment, employees are eligible for UI for the lost wages). Expanding that program would help workers stay attached to firms. In all these cases, there is a need to fund these expansions at the federal level, as state UI trust funds could not handle the surge in cases along with an expanded role.
SNAP is one of the most efficient and effective automatic stabilizers in the fiscal policy toolkit. Over 38 million individuals received food aid via SNAP before this crisis. Recent legislation has waived SNAP work requirements, allowed states to increase SNAP resources to households, and provided other food security programs and resources that support pregnant women, young families, children, and the elderly. Further legislation could waive work requirements until the economy has recovered and increase the value of SNAP benefits for all participants, and even more-so for families with children, as a simple mechanism to target cash-like resources to low-income families.
Q: Should direct checks be sent to all U.S. households?
A: We know that targeted help will not reach all who need it, so we should send help to all families. Such a plan would help those struggling but also provide additional purchasing power in the economy once social restrictions are lifted.
Millions of Americans who do not lose jobs may still lose income, tips, commissions, and hours. Too many American households live on the financial edge and will require support whether or not they meet eligibility requirements for safety net programs. As such, sending resources directly to all (or all but the highest income) households could provide a crucial cushion. A sound solution gaining momentum is to send checks (proposals range from $1,000 to $2,000) to households as fast as possible to help families immediately.
Speed is the essential parameter. Trying to target the checks based on prior income may slow the disbursement of funds and may be inaccurate as household’s circumstances have changed; it may be simpler to claw back some of the money for high income households based on 2020 taxes. Some proposals called for phasing in the size of the check with income (so those with little to no tax liability get less). There is no reasonable justification for the latter, as a payment based on prior income cannot have an incentive effect (one cannot go back and earn more in the past). Because the federal government may not be able to get checks to people fast enough, one option to quickly help the most vulnerable households would be to also provide cash to all SNAP and TANF households by putting non-restricted cash on existing electronic benefit transfer cards. As noted above, using economic outcomes to determine if more checks should be sent would ensure that Americans receive aid if the economy deteriorates sharply.
Q: Should the federal government help private industry?
A: This will not be a typical recession. In order for the economy to rebound once social distancing restrictions are lifted, it will be crucial that people have jobs to return to and firms still exist.
In most downturns, a combination of reduced business investment or spending by households reduces economic activity. This can, in turn, reduce hiring and production and in turn reduce spending even more. In those cases, stimulating the economy via lower interest rates or direct spending and transfers from the government can fill the gap of reduced expenditures. In the current case, though, economic activity is being curtailed by direct governmental action and business decisions to close in order to limit the spread of the virus. In the short run, stimulating demand will not help many firms. The problem is that if firms go bankrupt, restarting firms, rehiring workers, and reestablishing economic relationships can all be very costly. In some cases, there can be systemic issues where one firm going out of business can in turn bankrupt other firms (for example, suppliers). Governmental support during the crucial period of contraction will be needed in many cases.
Q: Under what circumstances—and to what extent—does it make sense to help companies?
A: The core principle guiding firms should be whether the aid makes it more likely that employment is maintained and systemic spillovers limited.
In a normal economy, firms go bankrupt all the time due to bad decisions, better competitors, or bad luck. It cannot be government policy to avoid all business failures. In this case, as noted, maintaining employment and business relationships will be crucial to the ability of the economy to bounce back. Firms that can operate in bankruptcy may want support to prevent equity holders from being wiped out, but that is not a goal of public policy. Equity investors took risks and have gained rewards over years; the government cannot prevent all losses. That said, where a bankruptcy would be disruptive to employment and supply chains, support is likely warranted in this unusual case. It is also important to focus on the bounce back after the contraction. Some industries may never look the same if individuals decide they no longer see the products or services as desirable. Government should not pick specific industries and try to help them maintain value, but rather focus on the overall functioning of the economy.
Small- and mid-size businesses in particular may need and warrant support. Major firms have access to capital markets for liquidity if needed, and typically have larger cash reserves and equity cushions. Firms that have paid out all their cash to shareholders via dividends or buybacks may be vulnerable, but those shareholders have recouped sizable returns. If some lose substantial equity value or even have to operate in bankruptcy, it may not be sensible public policy to invest large resources in them. To the extent that capital markets are seizing up, providing loans with some restrictions around maintaining payroll, bonuses, or dividends and buybacks make sense.
Smaller firms, though, lack such access to markets and buffers. They are also more likely to entirely cease operation than operate in bankruptcy. Government support—in particular, aimed at maintaining employment relationships—could make it easier for the economy to rebound.
Q: How can the government help small- and mid-size firms?
A: There are two fundamental ways to support small firms: loans or direct grants. Small firms are already seeing revenues disappear as part of forced closures or lack of consumer activity. The coming wave of closures of small firms—barring some sort of intervention—will likely dwarf anything seen before. The scale of the problem also dwarfs the Small Business Administration and its staffing and resources. A sizable government intervention will be needed.
A loan program could provide zero interest loans to firms under a certain size that are impacted by coronavirus (measured by industry and/or decline in revenue). If these loans were sufficiently long term and at highly conditional interest rates (perhaps zero), it would let small businesses stay in existence until the economy restarts and make them ready to surge back into operation. Making the loans non-recourse for some period of time (with constraints on maintaining some share of payroll) may remove some of the risk from small firms. These loans would need to be guaranteed by the government given the major solvency questions all firms currently face, making standard underwriting nearly impossible for banks.
Alternatively, the government could make direct grants to firms to cover some share of payroll expenses or revenue losses. Given the uncertainty about the economy going forward, many firms may worry about taking on more debt and might cease operation even if liquidity were offered on highly conditional terms. Covering some of firms’ costs directly, or making up revenue shortfalls, would likely keep an even larger number of firms in operation. That said, these grants would be extremely expensive and quite difficult to calculate. Some firms that cease operation will have drastically reduced costs even if they maintain payroll, such that making up revenue could be a huge windfall. Other firms may not survive even if payroll is covered due to other costs. Hybrids that make conditional loans available (and in some cases forgiven), subsidize payroll costs via tax credits, and remove payroll costs via job-sharing UI could also help a number of firms.
Q: What other fiscal measures can the U.S. government pursue?
A: The government is a major part of the economy. Every day billions of dollars are paid to the government and paid out by the government. Prudent policy would be to delay payments (tax filings, student debt payments, and small business loan payments) as much as possible to help households and firms through the most challenging months in the downturn. Conversely, the government can accelerate payments to suppliers and vendors to improve their cash flow during this difficult time. None of these actions entail true budgetary implications as they simply rearrange the timing of payments, but given the government’s ability to borrow at near zero interest rates and the challenges many families and businesses are facing in the short term, these actions could help.