Governments and central banks, helping largely

The stimulus measures being passed in response to the coronavirus pandemic are unprecedented. However, a recession seems inevitable. Who will ultimately have to bear the costs?

Talk about speedy responses! Many analysts have come to the conclusion that the economic slump in the United States and Europe could cause gross-domestic-product (GDP) ratios to shrink by up to a tenth. Plenty of (usually optimistic) economists have now turned to pessimists. The record 3.3 million first-time applications for unemployment benefits in the United States in the week ending last Saturday, March 21, illustrates just how fluid and dramatic the situation is. Even at the height of the financial crisis new weekly claims peaked at 0.66 million.  

The scale and pace of fiscal and monetary-stimulus measures to support the economy are also without parallel since World War II, if not before. By comparison, the interventions in the aftermath of the bankruptcy of Lehman Brothers almost twelve years ago look almost quaint. Back then, there was still wide-spread criticism of the hesitancy in the political decision-making process. By contrast, the speed this time around has been downright breath-taking. 

Monetary aid packages 

Central banks have cut interest rates at a record speed, to almost zero in most industrialized countries. Other monetary policy makers have not (yet?) followed the Eurozone experiment with negative interest rates. However, most major central banks have decided to buy bonds on a large scale, including corporate bonds. Their goals are to lower interest rates on longer maturities and to inject liquidity into the banking sector. In addition, the credit facilities for the banking sector were increased or new ones were created to secure the liquidity supply of the economy. 

Fiscal aid packages… 

Even more than on monetary policy, however, the focus is on fiscal policy. At the moment, the U.S. stimulus package in the amount of a whopping $2 trillion is making headlines. Not so long ago, two trillion dollars were brandished around as the order of magnitude for the expected global economic damage. Now, the U.S. stimulus package alone is already as large; the House of Representatives is expected to approve it on Friday. This is equivalent to almost 10% of U.S. GDP[1], which might serve as a benchmark for other finance ministers, too.

Broadly speaking, there are two types of economic aid: First, there is direct fiscal aid, such as short-time work benefits or the assumption of social-security contributions for companies that have been hit particularly hard by the Covid-19 crisis. Second, governments are offering loans and loan guarantees to ensure the supply of liquidity. In the case of Germany, fiscal aid amounts to 3.5% and loan guarantees to up to 14% of GDP. France has also announced fiscal aid of 1.9% and loan guarantees of 12.7% of GDP. The size of the aid packages in the United Kingdom is in between those of France and Germany. As a supranational institution, the European Union (EU) has initiated its own support measures amounting to 0.9% of the EU GDP.[2] 

...have still to be implemented... 

In view of the speed with which some packages are pushed through the legislative process, it seems almost impossible to rule out technical errors. It is unclear, for example, how and exactly when the U.S. government will deliver the direct transfers of $1,200 per adult and $500 per child, and how the promised checks will reach even the poorest (who are most in need of the aid). Further measures and clarifications on this, and similar packages in other countries, will probably be needed.

… and paid 

The question of who will ultimately have to bear the costs has also been postponed. Savers will probably pay a part of it in the form of even lower real interest rates on their savings or investments. The taxpayers will probably not get off scot-free, either. 

It's probably worth it: the measures taken by central banks and finance ministers are likely to cushion the economic slump. The risk that the economic downturn will turn into a wave of bankruptcies and thus a financial crisis has fallen, but it has not been eliminated. However, a recession seems inevitable. 

Aid packages do not rule out medical and economic setbacks 

The volatility in the markets is likely to continue, at least until the extent of the crisis can be fully assessed. This is not just a question of the number of new infections in particular countries, such as Italy. After all, the danger with Covid-19 seems as if every time there is a decline in one country or region, the next wave might already be underway in one or more other places. Vaccines and better medical treatments are also likely to be a long time coming. On the positive side, the dealing with the disease is improving in some countries and testing capacities are being increased. In the meantime, however, we should not lose sight of conventional sources of danger, from non-performing loans among Italian banks and Chinese property developers to ongoing turbulence in the market for high-yield U.S. corporate bonds. In times like these, staying power, patience and sound risk assessments are required. To panic would definitely be bad advice.

1. See: https://www.ft.com/content/0925d61e-6eaa-11ea-89df-41bea055720b

2. National Ministries of Finance as of 3/26/20

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