Coronavirus May Kill, but so Does Economic Disruption

Published April 1, 2020

Congress is preparing to pass a $1 trillion-plus package proposed by the Treasury Department to provide relief from the Covid-19 shutdown. Economist Tyler Cowen of the Mercatus Center has developed his own list of possible policies to mitigate the economic damage. How effective are these proposals likely to be, and what should be done?

Much of what is proposed is injection of credit and monetary stimulus, the sort of remedy often used, for better or worse, to solve a liquidity crisis or boost aggregate demand. It’s what macroeconomic policy makers know how to do. But it’s doubtful that these stimulus proposals offer the right approach.

The stimulus approach fails to address the fundamental causes of the economic downturn, while it balloons the deficit to no good end. The current economic crisis doesn’t originate in illiquidity, insolvency, or lack of consumer demand. Rather, the immediate problem for the United States is primarily related to the effects of lockdown, quarantine, and especially fear of quarantine. Also, supply chains will be disrupted, particularly from China’s shutdown.

In the end, the only real solution to the economic damage from the shutdown is to end the shutdown. Closures should be kept to a minimum, the minimum in breadth and length that reasonable epidemiological concerns warrant. The shutdown stops the production of goods and services; no amount of credit, currency, loan forbearance, or other financial remedies can replace that.

Stimulus Isn’t the Medicine for Quarantine

Lockdown and quarantine have short-term demand side effects and long-term supply side effects and call for a different set of policies from the stimulus approach. These policies should address the supply side shock and do so with as little additional debt as possible. There’s no way to avoid economic loss and an increased deficit during this crisis, but both are harmful, and we should minimize the total damage.

The initial impact of Covid-19 for most Americans has been the wave of panic-buying of food, paper products, over-the-counter medications, and the like. This panic buying is quite rational; faced with the possibility of weeks of quarantine, people stock up. That’s an increase in demand.

Stores’ unfortunate tendency to hold down prices in the face of sharply increased demand, and the irresponsibility of government officials who threaten investigations and prosecutions for “price gouging,” have exacerbated the problem and led to widespread shortages. This triggers further panic, and the lack of price flexibility dampens the supply response we would observe if prices were allowed to rise in the face of increased demand.

But that’s the immediate problem, and it could be solved quickly. Stocks of goods can be replenished and panic curbed. Prices that rise in the face of increased demand would help. Goods available, but at higher prices, discourage both hoarding and panic.

The Bigger Issue Is Long-Term

The bigger issue is the longer-term supply shock. The lockdown has shut off economic activity; it has reduced the production of real goods and services. These real losses cannot be undone by monetary stimulus. This supply shock will deepen when supply chain disruptions from China and elsewhere arrive.

The more extensive the shutdowns and the longer they last, the greater the real shock. Stimulating aggregate demand won’t work when output cannot increase. With that in mind, consider the Treasury and Cowen proposals.

Treasury proposes giving each American two direct payments of perhaps $1,000 ($500 for children). For those who are locked out of work and without a paycheck, these emergency payments will help, but for those who are not out of work these payments are unnecessary. The problem for the economy is not lack of stimulus; it’s the closures, whether mandated or merely recommended.

Treasury also proposes relief for small and medium business, particularly in credit to help with payroll and debt repayment. For business that are shut down, this will help tide them over, but it’s simply a transfer that helps stave off bankruptcy; it won’t boost production.

The big picture is that Treasury is accustomed to propping up financial markets and stimulating aggregate demand via liquidity injections. They have a hammer, and so to Treasury every problem becomes a nail. But some problems require something other than a hammer. Monetary stimulus is not the solution in this case.

Why $1,000 to Everyone Is Not Ideal

Cowen offers an alternative approach. His proposal is a grab-bag of many different policies, some of which address the supply issues and make sense. His ideas of relaxing occupational licensing and work approval, reducing labor regulations and payroll taxes that increase the cost of employing people, freeing prices and not enforcing price-gouging laws would reduce costs and stimulate production without adding to the federal deficit.

His calls for temporary bankruptcy reform for small businesses and default forbearance for consumer and mortgage debt would help limit catastrophic consequences for those most hurt by the shutdown. These also don’t require expenditure by the federal government (although payroll tax reductions decrease federal revenues).

Bankruptcy and default relief do put a burden on lenders. But the banking system is already backstopped by the Fed, and similar temporary emergency relief could be provided for other lenders on an as-needed basis. The idea is to keep people and firms from financial ruin while they wait out the crisis.

Cowen also calls for an immediate $1,000 cash payment to every American. It’s hard to understand why this is an attractive idea or how it helps. If the shutdown is relatively short, those who have weathered it well do not need support. Targeted support for those who live paycheck-to-paycheck and have been out of work makes much more sense.

I would love, but don’t need, $1,000. On the other hand, a laid-off restaurant worker trying to decide how to pay rent until the restaurant re-opens might need it badly. And if the shutdown is long, handing out spending money to any of us won’t make up for lack of production.

Here’s What to Do Instead

Instead of handing out thousand-dollar checks willy-nilly, it would make more sense for the federal government to offer zero-interest loans with long repayment terms to less well-off citizens who are able to show need. If we must make direct cash payments, target them to those in need. Again, the idea is to save people from personal financial ruin, not boost aggregate demand.

Cowen also suggests ceasing trade wars and eliminating tariffs on medical equipment and supplies. Yes. It would also make sense to work on rapidly developing new upstream supply sources outside of China by calling for a fast and drastic elimination of trade barriers globally.

It would also make sense to work on rapidly developing new upstream supply sources outside of China.

The economic downturn is not limited to the United States; it is worldwide. Cost reductions of this sort would stimulate supply and growth, something that is in all nations’ mutual interests. Cowen adds that we “should not stop our campaign to keep hostile foreign companies out of our communications systems.” That’s a good point; China has proved to be a bad player.

He additionally suggests the federal government stimulate medical innovation by protecting medical patents. At the same time, the federal government could purchase such rights and place them in the public domain to maximize availability. Similarly, he proposes government-sponsored prizes for innovations that address Covid-19. These also address supply issues and are specifically targeted at the underlying source of the economic problem, and hence are sensible.

Coronavirus may kill, but so does economic disruption. Recessions lead to increased drug and alcohol abuse, divorce, depression, suicide, and higher mortality. And we need to ask, how deep can production cuts go before people begin running out of basic goods and services?

Policy makers who are proposing economic interventions to fix the economic problem had better realize that the problem is the shutdown, not the virus. The virus may be dangerous, but so is the shutdown, and policy makers should take care that in addressing one threat they do not create a problem that is even worse.

[Originally posted at The Federalist]