How should we fight the economic fallout from Covid-19?
Last week’s sharp fall in global stock markets has highlighted the scale of the threat to the global economy posed by the spread of Covid-19. The underlying driver is different to the global financial crisis ten years ago, but like then, finance ministries and central banks have a critical role to play in an effective and coordinated response; they also need to play their part in ensuring that the world acts decisively to reduce the future risk of infectious disease outbreaks.
The role of traditional monetary and fiscal policy
While this economic shock could be on a similar scale to the global financial crisis, it comes at a time when the scope for additional conventional monetary easing is far less than it was in 2008, with nominal interest rates close to the zero bound in most major advanced economies. The US Federal Reserve had been the main exception, but they acted on 4 March to reduce interest rates by 0.5% points. This, together with the nature of the shock – originating from health security concerns rather than fear over the stability of the financial system – limits the scope for monetary policy to play a primary role in mitigation. Indeed, central banks and financial regulators have other financial stability tools which are likely to be more important in managing the crisis. Nonetheless if central banks are able to convey a credible message that G7 and G20 economic authorities are ready and willing to work together in a coordinated manner, despite US efforts to downplay and reduce multilateral economic cooperation over the past three years, this could prove valuable.
The coordinated fiscal response to the global financial crisis was equally important to the monetary response, and here the substantial decline in fiscal deficits since 2010 has increased the scope for supportive action, including through allowing automatic stabilisers to operate in full if the spread of the virus has a major impact in cutting tax revenues and boosting health and other public sector spending. But high public debt levels in most advanced economies remain a constraint, as will the concern not to underwrite through blanket measures “zombie” companies that may only have been sustained by a decade of ultra-low interest rates. Moreover, as with monetary policy, the nature of the shock means that having the right measures targeted on reducing the cost of containment measures and minimising the long-term damage to the most vulnerable sectors could be more important in practice than the scale of the general easing.
The role of fiscal and monetary authorities in managing an epidemic economy
Thus, finance ministries and central banks both have a critical role to play in managing the crisis through other means than broad based monetary and fiscal easing. Moreover, like their counterparts in health ministries, they need to make the best use of the delay being bought by containment measures to develop the tool kit they may need later on.
What makes this challenging is that despite the very real progress made in understanding Covid-19, the aspects that remain uncertain are often crucial to determining the optimum economic response. Each country is likely to face a critical decision on when to move from policies which put containment above all else, to those which focus on protection of the most vulnerable (the elderly and those with pre-existing health conditions) and treating the sick, while enabling the majority of people who are much less vulnerable if they catch the virus to get on with daily life (albeit still seeking to delay spread of the virus through increased personal hygiene, and moderate social distancing measures). Moving from a strict containment strategy too soon could accelerate spread of the virus, while moving too late could have severe economic consequences which would ultimately be self-defeating if they were to lead to significant food shortages and substantial long-term damage to the economy. When to make the switch will depend crucially on the circumstances in each country and such current unknowns as how far the virus has already spread, the mortality rate in the country in question, the likely benefits of delaying until the weather warms (in terms of extent and severity of infection) and the speed with which a vaccine will become widely deployable. It will also depend on what measures are actually needed for strict containment – e.g. whether it is necessary to close schools which in turn depends on how vulnerable children are to the infection.
Therefore, a first crucial role for finance ministries and central banks is in providing the best possible economic evaluation of the impact of alternative containment measures, playing a full part, alongside health experts, in advising political leaders on the crucial decision of when to switch from strict containment to “managing” the spread of the virus.
Second, they have the lead role in doing whatever is necessary to ensure that financial markets will continue to function smoothly, even if large numbers of staff are required to work from home or fall sick.
Third, they need to ensure adequate funding for the public health response. Steps that can make an enormous difference to the success of containment strategies, such as strengthening surveillance, and guaranteeing the availability of testing kits and protective equipment for front line health workers, must not fail because of a lack of funding.
Fourth, they have a lead role in designing targeted economic interventions for the wider economy. Some of these are needed immediately to re-enforce and incentivise strict containment strategies, such as ensuring that employees without full or adequate sick leave cover have the financial support to enable them to report and self-isolate when they get sick. Other interventions may help improve the resilience of the economy in accommodating moderate “social distancing” measures, e.g. by providing assistance to small firms to help them gear up for home working. Yet others are needed, as a contingency, to safeguard the most vulnerable sectors (such as tourism, retail and transport) in circumstances where there is a prolonged downturn. Tourism is one of the largest economic sectors in many advanced and developing countries, crucial for export earnings and employment. And yet it is also among the most vulnerable to the likely impact of Covid-19 and, since it is dominated by small businesses, one of the most fragile. Economic authorities therefore need to work out how they can ensure adequate support – e.g. by allowing deferral of tax payments by SMEs, or steps to encourage loan extensions and other forms of liquidity support from the banking system, or by moves to underwrite continued provision of business insurance.
Fifth, national economic authorities will need to play their part in combatting “fake news” through transparency and high-quality analysis. This includes providing forecasts on the likely economic impact of the virus under different scenarios, but also detailed information on the support and contingency measures they are considering, so they can be improved and refined through feedback. This role for economic authorities will be particularly important in those governments where the first instinct is to hide or sugar-coat bad news, since it is only through accurate information that firms and markets will be able to prepare for the most effective response at minimum cost.
Sixth, they will need to ensure that there is generous international support for poor countries, by ensuring the available multilateral support facilities from International Organisations (such as WHO technical assistance, the World Bank Pandemic Emergency Fund and the IMF’s emergency financing facilities and Catastrophic Containment Relief Trust) are adequately funded and fit for purpose. The World Bank has already announced an initial $12 bn financing package, but much more is likely to be needed. They also need to support coordinated bilateral aid where this is more effective, as well as special measures to support particularly vulnerable groups e.g. in refugee camps and prisons. Given the importance of distributing sophisticated medical equipment and expertise quickly to those countries that most need it, every effort needs to be made to avoid delays due to customs and migration checks. If poor countries do not have adequate external financial support, or access to the equipment they need, they may be forced to abandon strict containment measures sooner than is optimal from both their own perspective, or the broader international community.
Managing the future
While the response to the immediate crisis will rightly take priority now, economic authorities must also prepare to play their part in ensuring that the international community finally takes all the necessary long-term steps to minimise the chances of a repeat of Covid-19 in future. The experience with SARS, H1N1 and Ebola shows that, while some progress is made after each outbreak, this does not amount to a decisive and sustained campaign to minimise the risks of the kind of economic shock we are experiencing today. The experience of the last month shows that this is absolutely critical to the long-term health of global economy, and doubly so in circumstances where the traditional central bank and finance ministry tools for dealing with major global economic shocks are limited.
In this respect, finance ministries and central banks need to push hard within government to ensure sustained long-term funding of research on prevention – particularly on the threat of infectious diseases emerging in wet markets and how best to address this – but also on contingency measures, such as the work of the Coalition for Epidemic Preparedness Innovations (CEPI) on rapid vaccine development. Covid-19 may well throw up new areas in which international coordination is needed, and these will need to be funded. It should also add urgency to the campaign to achieve universal health coverage and strengthen publicly-financed health systems in the poorest countries, since such systems are, among other things, crucial to the early detection and treatment of new diseases.
Economic authorities also need to ensure that the right lessons are drawn regarding the need to make international supply chains more robust to shocks of this kind. This does not mean abandoning complex cross-border supply chains. Indeed, doing so could make a business more vulnerable rather than less (e.g. if its entire business happens to be located in one of the first countries in which a new infectious disease takes hold). But it does mean active scenario planning and risk mitigation, something central banks and financial regulators can encourage through their oversight of bank lending to multinational corporations. There may also be supply chain issues on which businesses need coordination by governments in order to come up with the optimal solutions; and it is important to ensure that this kind of collaboration is not prevented by an excessively broad interpretation of national security.
The need for global leadership
Some national economic authorities are already taking many of the actions set out above. Others will step up in the weeks ahead. But critical to the overall success of the economic effort, as with the effort among national and international health bodies, will be effective international coordination. The G20 was established as the premier economic forum for international economic cooperation in 2010 and it remains the most appropriate forum for overall coordination of the economic response to Covid-19 at both leader level and finance ministry/central bank level. This role is helped by the German initiative in 2017 in making global health issues a substantive part of the G20 agenda; and this has been complemented by meetings of G20 health experts and health ministers. At the same time, this year’s G20 President, Saudi Arabia, as a relatively small country hosting its first major global economic summit, should be offered strong support by larger members in taking on this challenge. G7 Finance Ministers and Finance Deputies continue to be one of the most effective bodies for managing economic crises on a day to day basis, and they should play a critical role in this respect within the framework provided by the G20. But to do this, the G7 will need to work exceptionally closely with China. The US chairs the G7 in 2020 and it is critical that the Administration put aside its reservations on multilateral economic cooperation and working with China to provide strong and effective leadership.
Creon Butler
Director, Global Economy and Finance Programme
Chatham House
