Supply and demand
This crisis is very much a race between supply and demand, Professor Surico says. At first sight it looks like a classic supply side shock – disruption in China and global supply chains, followed by quarantine and social distancing reduce the number of hours worked.
But uncertainty – in people’s health, their finances and their business prospects – stops people spending, and so demand is hit also. Firms are wary of investing, and also lack the funds to do so. In this way a recession becomes a depression, and prices start to fall.
Sadly, this is not the end of the story, Professor Surico adds. Firms close down, and this brings aggregate supply down. Consumers (workers) are forced to reduce consumption even further.
The destruction of economic surplus
If we assume a drop of 50% of output for a month and 25% in the two following months, that would amount to a 10% drop of GDP in a quarter, which would be “humungous”, according to Professor Surico. And that would apply if the lockdown only lasts three months. This could spiral to more than 15% if it continues. By way of contrast, total output lost globally in the great recession of 2008-9 was 4.5% over two years (which has not yet been fully recovered, by the way). So this fall could be three times bigger.
Social costs
The impact will be felt not only in GDP figures but in people’s lives. We have already seen a big rise in demand for mental health services. Stress levels for people at home with children, trying to work and home-school, can be high. Alcohol consumption seems to have spiked in March, with drink being both stockpiled and consumed. Higher drinking can of course be stimulated both by mental health problems or worries about unemployment.
A 3% rise in unemployment can lead to a 25% rise in alcohol abuse. And then there is the question of domestic abuse, which could have risen as much as 30%, and not all cases are reported.
For children, too, inequality can rise. Not all will have access to home schooling and the internet, so their education will suffer. There seems to be a clear link between household income levels and educational chances and attainment. In low income families children do worse in times of home schooling. So the crisis adds to disadvantage. There is a risk of “double inequality” – parents can’t look after them and there is also a lack of internet access, so education gaps will grow.
Income gap
Workers do not suffer equally either. Higher earners are more likely to be able to work from home. Lower skilled workers are more likely to lose their jobs. They are more likely to be put on furlough, more likely to be laid off, and less likely to be able to work from home.
Macroeconomic interventions and policies
The extremity of the situation calls for significant and large scale policy measures, Professor Surico says. More spending on public health has become inevitable. Tax reliefs and tax holidays have been tried, even a de facto temporary universal basic income under the furlough programme, with the government paying 80% of people’s salaries. Interest rates have been cut and there is the possibility of more quantitative easing.
“Tax rebates, cash grants and some form of temporary universal basic income are the most effective intervention for now,” Professor Surico suggests, as they puts real cash into people’s hands, which they spend. We could even experiment with a pre-paid debit card which expires whether a person has spent the money or not – to encourage a kind of compulsory spending.
Action now
Whatever mix of options is chosen, policies need to be “now and massive”. A 15% loss of GDP is an immense hit. Action will have to be global and co-ordinated, Professor Surico says.
Politics used to be needed to fix the economic cycle, he says, but now the economics is needed to try and fix the political problem.
Debt should not scare us as growth will eventually restore public finances, Professor Surico adds. He concludes: “I never thought in my life I would ever advise governments to do this, but it is time to print money. Deflation is the problem, not inflation.”
Central banks can raise rates and withdraw liquidity in due course at the right time to deal with any inflationary pressures. Bad government can lead to hyperinflation, he says, but that is not our immediate concern.