We are at war. It is not a war between good and evil, it is a war against a virus, a new, invisible enemy that multiplies every week. The human brain is not well prepared to manage novelty, it needs a script to help it navigate. It also doesn’t know how to adapt to what it can’t see, that’s why we are scared of darkness. And, above all, it does not understand processes that are not linear; the rapid multiplication of infections and deaths, although predictable, generates panic. This war, in addition to victims, generates anguish and fear.
The enemy must be attacked at the root, fast, without hesitation. With a strategy based on three pillars.
First, health policy must take command of the situation, providing it with all the economic, material and human resources necessary to quell the virus and minimize victims. The key is to flatten the contagion curve to avoid the collapse of the health system, and this requires social distancing and that we all behave as if we have already contracted the virus and do not want to spread it to anyone. Let’s all strictly comply with the health recommendations; solidarity begins with oneself.
Second, fighting the virus will carry an economic cost, one that will probably be huge. In cases of relatively low mortality, studies show that social-distancing decisions are the fundamental variable to determine the negative impact of a pandemic on economic activity. Social distancing is a form of “human sudden stop”, similar to the sudden stops of capital markets. Suddenly, what used to be normal stops being normal. Overnight, customers do not appear in the restaurant, in the gym, in hotels. The economic policy response must alleviate this sudden stop: provide aid, subsidies and guarantees that limit the impact of this disappearance of activity and minimize bankruptcies and layoffs. With the addition that, in this situation, there is no moral hazard, as it is not forgiving previously irresponsible behavior. The plan must combine an aggressive relaxation of monetary policy and aid to companies, workers and families, with the active collaboration of the banking sector: ensure the liquidity and survival of companies with guarantees for new loans and moratoriums on taxes and rents; minimize job destruction with partial payroll payments, help for self-employed, and temporary employment subsidies; and shield the incomes of the less-favored families with mortgage moratoriums and reinforcing unemployment subsidies and minimum incomes. The European plans, including the Spanish one announced this week, are following this path.
Third, ensure that, after having defeated the enemy, the landscape after the battle is bright and optimistic, so that there are no chronic consequences after what may be a drop in GDP of dimensions never seen before. It is not enough to mitigate the negative impact of social-distancing measures. The consumption that is lost during the fight against the virus is consumption lost forever. Once a certain normality recovers, economic reconstruction should be based on an impulse that helps to recover as soon as possible the level of GDP that we would have generated if the virus had not appeared. And that requires a well-designed, multi-year fiscal stimulus plan that boosts investment and employment after the crisis. In technical terms, hysteresis must be avoided at all costs. Each country has different needs, it can be investment in the digital economy, green energy, improvement of education... Whatever it is. With zero interest rates, there is no reason not to do it.
Wars cost money. The deficits will increase very significantly after this crisis. It is the cost of victory. And, then, we will have to avoid repeating the mistake that was made after the 2007 crisis. No, we should not immediately think about reducing the debt and the deficit. The priority should be to support growth, close the output gap, and increase inflation to the target. It will be time to “Japanize” the economy, in the positive sense of the word: the central bank must cooperate explicitly with fiscal policy, so that interest rates remain below the growth rate of the economy for a long period of time. And if that means keeping interest rates very low and continuing to buy bonds for many years, as will surely be the case in the eurozone, then so be it. This will not be a rescue from this or that country. It will simply be complying with the mandate of price stability, whatever the cost.
This war represents an existential challenge for the eurozone. There are no longer creditors and debtors. We must end the inertia of the programs, the bailouts, and conditionality. Let’s admit it: faced with this shock – exogenous and common to all – if member countries are not willing to mutualize the solution, issuing Eurobonds to finance a program of economic reconstruction, they will never be.
Ángel Ubide is an economist and a member of the international advisory board of the Center For Economic Policy & Political Economy. @angelubide