What if this time were different?
The eurozone, unlike the United States, seems content with an incomplete recovery, but this doesn’t have to be the case
The secret of success in track and field depends on the specifics of the race: in the 60-meter dash, it is all starting technique and explosiveness; in the 100 meters, starting technique and acceleration; in the 200 meters, it is imperative not to lose speed in the curve. In the 400 meters, the toughest race of all, speed must be maintained until the end, without ever slowing down. It is a sustained sprint at maximum speed that must overcome the tyranny of the lactic acid, which hammers your muscles and your mind demanding to slow down. The optimal post-Covid economic policy is like a 400-meter race: it is not enough for it to have an impeccable start (the provision of immediate and unlimited liquidity) and fast acceleration (the furlough schemes and the aid to households and corporations), it must also maintain the sprint until the very end, overcoming the temptation and fatigue that lead to loosening up and keeping the economic stimulus going until we have fully recovered from the impact of the crisis.
However, the trend in economic policy in recent years has often been to give up before reaching the goal. The recessions of the last decades have been followed by very weak and prolonged recoveries, which failed to recover the level of gross domestic product (GDP) that was expected before the recession, and created disinflationary risks. The main cause has been the opposition – for primarily ideological reasons – to the use of monetary policy measures that go beyond interest rate cuts, such as asset purchases. This opposition has prevented such measures from being used quickly and effectively, which in turn, limits the active use of fiscal policy.
The eurozone has delivered abundant support to offset the Covid restrictions, but economic projections suggest that it is not willing to maintain the sprint at maximum speed
Similarly, after financial crises, the opposition – for primarily political reasons – to the use of the necessary measures, such as support for systemic entities, has led to greater economic deterioration than warranted and prevented the economy from healing as quickly as possible. It has not been due to a lack of ideas or instruments, but rather to the stubborn opposition to their use and the resulting cautiousness in their deployment. Therefore, it should not be extrapolated, nor should it be accepted, that all recessions should have equally weak recoveries, it all depends on how they are managed.
Nor should connections be made with persistent phenomena, for example, the secular fall in interest rates, mainly due to the fall in equilibrium interest rates. Multiple causes have been advanced, among them the increase in savings (for example, due to the accumulation of reserves in Asian countries and global fiscal austerity), the weakness in investment (for example, due to the increase in intangible investment – as Greenspan said, the GDP “weight” has been reduced), the slowdown in productivity, the tightening of financial regulations and the increase in risk aversion. As in Murder on the Orient Express, there are many suspects, but not a single culprit. This difficulty in identification leads to the inertial assumption that the trend will continue.
But what if this time is, or could be, different? To begin with, this recession is different; it was not caused by overheating or by financial excesses, but by an exogenous health shock. As we have already pointed out several times, it is an induced economic coma and, with the appropriate economic policy measures, the rebound should be proportional to the decline. Of course, the coma will have caused some damage that will take time to heal – but it has also generated changes that are positive for future growth.
Furthermore, the economic policy measures have been different. The lessons of the previous recession – i.e. the acceptance that zero interest rates do not generate asset bubbles, that asset purchases do not generate moral hazard and that the increase in central banks’ balance sheets does not generate hyperinflation – have allowed a much more aggressive and rapid response.
Therefore, GDP projections in some countries, such as the United States, are beginning to show a profile very different from previous recessions, forecasting a recovery in the next few quarters of the level of GDP that would have been expected had the pandemic not happened. Why couldn’t the same happen in the eurozone, where the current forecast is that this level of GDP will never be recovered, similarly to previous recessions? The impact of the virus has been similar on both sides of the Atlantic, there should be no differences in the recovery.
Let’s not allow the fatalism of austerity rule again in the eurozone. Let’s not accept the disinflation and hysteresis of the past
Similarly, potential changes can be observed in equilibrium interest rates, especially in the US. The excessive propensity to public savings has decreased, and the weakness of public investment is likely to be corrected (for example, with the European recovery and resilience plans, or the infrastructure plan being prepared by the US administration). Investment in technology has accelerated (in part due to the need to work from home), and even the most techno-pessimists, such as University of Chicago professor Robert Gordon, acknowledge that the future of productivity growth is perhaps brighter than they thought. The regulatory tightening of the financial sector has stabilized, and fintech has expanded the investment universe. Could this set of factors create the conditions for a gradual rise in equilibrium interest rates?
A world with a faster recovery, which does not result in a permanent loss of GDP, and with slightly higher equilibrium interest rates, will be a more balanced and prosperous world, with more room for inflation to increase to its target and for monetary policy to efficiently manage the business cycle. The US has chosen to keep the sprint at maximum speed until reaching the finish line, to ensure that this recovery is different – with a fiscal package calibrated (and supported by the Fed’s strategy) to restore maximum employment as soon as possible, and well designed, with special attention to reducing child poverty, that will be complemented with another package focused on infrastructure, green energy and education.
The eurozone has delivered abundant support to offset the Covid restrictions, and has created the recovery and resilience fund, but economic projections suggest that it is not willing to maintain the sprint at maximum speed until the end and restore maximum employment as fast as possible, and seems content with an incomplete recovery and a loss of GDP. It needn’t be this way. Let’s not allow the fatalism of austerity to rule again in the eurozone. Let’s not accept the disinflation and hysteresis of the past; let’s fight them instead. Now that victory is at reach in the battle against Covid, let’s plan for an ambitious post-war reconstruction so that the eurozone recovery will also be different and no GDP will be lost. Let’s finish the race.