The coronavirus pandemic has devastated large portions of the global economy, with widespread social-distancing efforts leading to plummeting productivity and soaring rates of joblessness.
In the United States, comparisons between the current crisis and the Great Depression have become common. U.S. policymakers, notably the Federal Reserve, have taken extraordinary measures to attempt to solidify the country’s economic foundation and pave the way for a return to a fully functioning economy once the pandemic ends.
Darden Professor Kinda Hachem, who teaches in the School’s Global Economies and Markets Area and is a faculty research fellow at the National Bureau of Economic Research, recently offered her thoughts on the state of the economy and the extraordinary efforts underway to prevent further collapse.
It has been a whirlwind month for the global economy. How would you assess the current landscape?
I would liken the economic downturn to a medically induced coma, with monetary and fiscal policy providing life support.
Yes, there have been various economic shocks stemming from the coronavirus pandemic, including supply chain disruptions and decreases in demand from lower expectations of future income and lost wealth, but the biggest shock is coming from preventative measures like physical distancing and shelter in place. These are inherently contractionary.
However, for the greater good, there is no other choice. Our Darden colleague Professor Anton Korinek and UVA Economics Professor Zach Bethune estimate the social cost of each additional infection at nearly $290,000, which is 3.6 times the private cost they estimate any individual agent would internalize. That means, without intervention, we will never achieve the preventative measures that public health officials think is necessary to get this virus under control. To give hospitals and other front line workers a fighting chance, we have to shut down.
The medically induced coma, or life support, analogy is important to make because it helps calibrate our expectations of what success is going to look like. Just like we don’t expect someone to run a marathon while on life support, we shouldn’t expect a fully functional economy right now. That’s not what the Fed and U.S. Treasury are seeking. The goal is to keep enough money flowing through the usual channels so that those channels and the businesses dependent on them don’t die out before we reopen. That’s the economic version of life support. We will see Depression-era unemployment numbers initially, but success will be how fast we go back to 4 to 5 percent unemployment when the public health part of this is over.
What do you make of the Fed’s moves so far, and what is the most important action it can take to help prevent a deeper economic collapse?
The Fed has acted swiftly and aggressively. I would also give the Treasury some credit here. The biggest boost the Fed can give is through its 13(3) emergency powers. That allows it to conduct much more targeted policy, directing funds to the parts of the economy that need it most rather than relying on financial markets. But to open 13(3) facilities, the Fed needs approval from the Treasury. It also needs the facilities to be adequately collateralized, which the Treasury can help with by providing an equity investment. So, the Treasury has given the Fed the green light to act and the Fed has definitely responded. I think they’ve been tremendous.
I think the Fed needs to keep providing liquidity where it’s needed and, of equal importance, get the details right. The devil is always in the details, which, in this context, means implementation. The Main Street Lending Program, for example, is an innovation. The Fed will facilitate up to $600 billion in lending to small and medium-sized businesses. It’s one thing to want to get $600 billion to small and medium-sized businesses, it’s another to get the $600 billion to the firms that need it most. Banks are going to originate the loans, and the Fed’s facility — again, with an equity investment by the Treasury — is going to take on 95 percent of the exposure, which is unprecedented and really a testament to how much the Fed is willing and able to do. The key is getting the right things originated.
That being said, there’s only so much the Fed can do, even with innovative monetary policy. Fiscal policy is crucial. Yes, 13(3) helps create targeted facilities, but fiscal policy is a much more direct tool during a public health crisis.
Crashes sometimes usher in a new era of financial regulation. Do you think that’s likely here?
Financial crashes often do lead to financial regulation. It’s unlikely here since the problem didn’t originate in the banking system or in financial markets. The Fed has relaxed some financial regulations to make sure banks have no regulatory excuse not to lend. We’ll see the Fed tighten these regulations back up as we emerge from this episode. There may even be a period of time where the regulations are tighter than prepandemic as the Fed works to siphon out excess liquidity when we’re on the other side of this. But, overall, no I wouldn’t expect new financial regulation stemming from the coronavirus pandemic.
What’s your best informed guess about when we might get back to prepandemic levels of global economic activity?
This is hard to answer with any certainty since it depends on solving the public health dimension first. I don’t think we can have a normal economy until there’s mass testing that’s accurate and fast. Testing doesn’t mean the problem is solved, but it will allow public health officials to regain control of the situation, which is a very necessary step for reopening the economy. Ideally, we’ll see strong signs of recovery within two quarters of mass testing. The time from mass testing to recovery is where we have to look to judge the Fed’s success — and the Treasury’s success. It’s going to depend on how much we were able to keep afloat during the shutdown so that those things would be ready to start back up when we reopen. Payroll support to firms is a good example of something important here. Furloughing is much better than laying off when it comes to restarting. It takes time to hire people back, especially in jobs that require specialized skills and skills accumulated over time within the firm.
One dimension of economic activity that I think will not be the same as it was prepandemic is trade. This episode is going to make us revisit how we calculate the gains from trade. Specializing based on comparative advantage then trading is obviously still useful, but being too dependent on one supplier or one country for critical inputs, especially in the pharma space, is a huge risk. Just like we wouldn’t want banks to get all of their funding from one person, we need to balance specialize-then-trade arguments with diversify-your-portfolio arguments.
You’re an expert in funding markets and monetary policy. What fascinates you about this moment?
The unique and fascinating part is that we’re making a social choice to shut the economy down. There is technically the trade-off of save the economy versus save the people, and I say technically since it’s obvious to me on which side we should land here — save the people. But it’s rare to have to confront this trade-off so sharply.
In some sense, the full economic considerations of the pandemic put the social back into social science.