Economics professors talk about the pandemic and what it will take to recover
For the United States, the pandemic caused one of the largest daily drops in the history of the Dow Jones Industrial average and drove the federal government to write a $2 trillion stimulus bill while the central bank dropped interest rates to near zero.
Businesses shuttered for weeks. Schools closed. Unemployment rates surged. Oil companies began paying buyers to take the product off their hands.
It leaves many people wondering what will happen next as new cases level out and the economy starts up again. Will consumers be reluctant to spend? Will the unemployed quickly return to work? Will department store chains, already teetering, be toppled? Will another wave of the virus push the economy from bad to worse?
We have gathered a roundtable of economic experts to discuss what you may not hear in the mainstream news.
How long will it take the economy to recover?
Julie K. Smith (JKS): I am going to provide the economist’s answer: It depends. Consumption makes up almost 70% of real GDP (national output), so what happens to households who do all this consumption will affect what happens to the economy. If consumers believe they will be recalled to their jobs and that others will buy goods and services, then their spending will more likely be restored. Greg Mankiw, Harvard University macroeconomist, called the current recession we are having a “recession by design,” so if policymakers can mitigate the negative effects, then the economy is likely to recover sooner. The recovery will be greatly influenced by how well the country keeps infections under control. One fear is that resuming activity too soon will lead to spikes in infections and then having to “close” the economy again. The infection rate will determine if we could see a u-shaped or w-shaped recovery, but a v-shaped recovery seems very unlikely given testing capacity and contact tracing capacity.
What consumer behaviors should we expect as states/cities reopen?
Joaquin Gomez-Minambres (JGM): Consumers’ confidence and expectations are more based on emotions than on reason. We call this way of thinking “availability heuristic,” the tendency to assess the probability of an event based on the ease with which it can be imagined. For example, in the aftermath of an earthquake, insurance for earthquakes rises sharply; and it declines steadily only as the vivid memory recedes. Regardless of the actual outcome of the virus, the COVID-19 crisis is likely to linger in people’s minds for some time, negatively affecting their willingness to consume and slowing down the recovery.
What will help consumer confidence?
JGM: We need leaders, both in government and in business, who can stay calm, project confidence, and provide comfort. We need leaders who can show empathy while people are suffering. We need leaders who can tell us: “The only thing we have to fear is fear itself,” or “If you are going through hell, keep going.” We need leaders who can instill confidence about the future during a catastrophic present. We need LEADERS.
JKS: I agree. Having strong leaders who are willing to use the fiscal power of the United States would go a long way to restoring or at least stopping the declines in consumer confidence we have seen. Jerome Powell, chair of the Federal Reserve, has shown tremendous leadership and pushed the Fed to pursue swift action, but he does not get the same press as Congress and the president.
Will employees be called back to work or will unemployment remain high?
Susan Averett (SA): Depends partially on the ability to do testing and contact tracing. If people are not comfortable going out to eat, for example, then restaurant hiring will be slow. Same goes for shopping for clothes and such.
What will we see with small business?
SA: Many will not make it. We may see a concentration of even larger businesses who are unable to weather this crisis. One advantage of the government-lending programs to small businesses is that they have to keep paying employees. That is helpful to the overall economy so that people can keep spending.
What will state and local governments need to restart?
JKS: State and local governments are losing large amounts of tax revenue. This is revenue that is truly lost, as it won’t be made up. Services are the biggest part of consumption (over 60%), and people cannot make up for lost haircuts or restaurant meals.
Erin Cottle Hunt (ECH): Many state and local governments have balanced budget requirements, which limits how much they can borrow to fund spending in the short term. Investor concerns about the ability of local governments to repay debt may also reduce demand for municipal bonds and drive up the cost of borrowing for states and localities. Fortunately, the Federal Reserve has stepped into this market and started buying municipal bonds last month. Also, state and local governments rely on federal grants as a large source of revenue, so increasing federal grants could be helpful.
Are the federal bills going to do enough? What else is needed?
Will the checks to citizens help?
SA: A check of $1,200 in a housing market like Denver or Los Angeles won’t go far.
JGM: The empirical evidence shows that when people receive an unexpected windfall, they are more likely to spend and hence stimulate aggregate demand. Most economists agree this type of stimulus will be more effective than other alternatives, such as lowering taxes. But will it be enough?
Will people spend checks correctly? Is the hope that people buy durable goods?
JGM: There is clear evidence that people save more during recessions. For example, before 2007 the personal saving rate in the U.S. was about 3% of the GDP. It more than doubled during the Great Recession. Whether this spending pattern is “correct” or not depends on what you mean by “correct.” Saving during recessions makes perfect sense from the point of view of the individual, but “collective thrift” might harm an economy by decreasing aggregate demand and hence economic activity in the short run. This is precisely why fiscal policy (government spending) is necessary during recessions.
JKS: On the durable goods question, I think this is the general confusion between monetary and fiscal policy. Lower interest rates provided by the Fed via Quantitative Easing may make it more attractive to buy a house since mortgage interest rates have fallen. It also may make it more attractive to buy household appliances and cars since households can finance those more cheaply assuming that a household has access to credit.
In terms of the stimulus checks, economists do not care what type of goods or service those are spent on. Under normal circumstances people are likely to spend and stimulate aggregate demand, but in this scenario, with so many businesses closed, people may not be able to spend the additional funds they received or feel comfortable taking a vacation or going out to dinner in a state that has reopened. The personal savings rate jumped in March to 13% from 8% in February as evidence.
SA: Housing lenders have upped their credit requirements, so while this may be a good time to buy a house or a car, some consumers will find that they are essentially locked out of those markets due to lower credit scores.
JKS: One idea is to send more money to all households in the U.S. over the next few months. Some have called this a temporary universal basic income. Another idea that I like is to send money to all Americans as either a grant or loan. Higher-income households would get a loan, which they would pay back over the next few years, but lower-income households would get a grant. A nice feature of this type of program and where the current stimulus checks missed out is for those who are newly unemployed. A household may have made too much money to qualify for a check last year or in 2018, but with job loss they would now qualify.
ECH: Some sort of recurring payment would be more helpful. This is especially true as states open their economies and some people will lose access to unemployment insurance (UI). For example, hairstylists and barbers won’t qualify for unemployment benefits if their salon reopens, even if the individual worker doesn’t feel like it’s safe to go back to work or even if the worker doesn’t have clients. (I’m not sure if this is universally true, but it appears to be true in Georgia and Iowa.) Recurring payments from the federal government could support these and other workers who no longer qualify for UI, or who go back to work but have reduced hours or reduced pay.
JKS: If there are any lessons to be learned from the Great Depression and Great Recession, it’s that doing too little will leave scars on the economy that take a long time to heal. For lower-income households that were just seeing the benefits of the economic expansion after the Great Recession, it will mean another decade of struggling.
ECH: I agree completely with JKS. I suspect that the crisis is going to exacerbate existing inequalities. I would also advise policymakers to consider hazard pay for essential workers.