A K-shaped recovery and the role of fiscal policy

The spine of the letter represents the fall in activity at the start of the pandemic. Then there is a split, which leads to the two ‘arms’ that capture the different directions taken by economic activity in different sectors.

 
The shape of the post-pandemic economic recovery has gone through many letter characterisations, from V to W, to land more or less on the letter K. The spine of the letter represents the fall in activity at the start of the pandemic. Then there is a split, which leads to the two ‘arms’ that capture the different directions taken by economic activity in different sectors.

Digital technology and pharmaceuticals, for example, have seen their activities boom. On the other hand, sectors including hospitality, tourism, and also energy, have seen partial or complete standstills. There have therefore been clear winners and losers from the pandemic.

Evidence shows that this K split that characterises different sectors holds also for individuals at opposite ends of the income distribution. After initial reductions in everyone’s income, the wealthy are now recovering fast, while lower earners are still struggling.

Any attempt to design further fiscal support for the remainder of the pandemic must account for this split, or it risks missing the point. The main role of fiscal policy therefore will be to support only those segments of the economy and society that are on the declining ‘arm’ of the letter K.

This is very much the logic behind the most recent fiscal rescue package in the US, which has three purposes. First is dealing with the health aspects of the pandemic, including assisting vaccination and making schools safe. Second is supporting those who have lost their jobs. Third is providing cash transfers to those with lower incomes.

How does this K-shaped recovery apply to the fiscal needs in the EU? In a letter to her G20 colleagues, on 25 February, US Treasury Secretary Janet Yellen urged her counterparts, at the very least, not to step back from fiscal support, saying among other things that “If there was ever a time to go big, this is the moment”.

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Πηγή: bruegel.org