The coronavirus disease 2019 (COVID-19) now seems highly likely to cause an economic slump, both in the United States and globally. Only a little more than 60 days after word of a mysterious and previously unknown illness first emerged from Wuhan, China, the Federal Reserve responded on March 3 by cutting its policy rate by an unusually large ½ percentage point. More unusual still, the Fed moved two weeks ahead of the next regularly scheduled meeting of its rate-setting committee. At this point, the real question is how severe and long the slump will be.
My answer is on the pessimistic side. Early estimates are that this disease is more transmissible and more lethal than the seasonal flu. Moreover, no vaccine currently exists to protect those who don’t have the disease yet, and no antiviral treatment currently exists to help those who do. Moreover, the public health countermeasures taken thus far in other countries appear exceedingly disruptive for economic activity (for example, closing schools for a month in Japan and constraining the movements of a vast number of people in China). The United States may have a hard time doing better.
A smart and rapid policy response is urgently needed.
Responding to the public health crisis should be priority
For now, the overwhelming priority must be to address the public health dimension of the situation with maximum speed and effectiveness. A first step is to lock in adequate public funding. In 2014, emergency funding of about $5.4 billion was provided to fight the Ebola outbreak. Much more than that should be provided today, given the apparently greater transmissibility of COVID-19 and the fact that it has already appeared in many locations around the United States and more than 60 countries around the globe. Fortunately, the mortality rate from COVID-19 is nothing like the fearsome death rate from Ebola, but that should not cause US lawmakers to stint in their provision of funding.
No effort should be spared in assuring adequate funding for developing rapid and accurate tests and making them widely available; stockpiling protective gear; training medical personnel; and providing ventilators, to name a few obvious steps. Given the vulnerability of the elderly to the disease—especially those with underlying health conditions—special focus should be put on helping long-term care facilities and other institutions that serve large numbers of such individuals.
Preparing an economic policy response is crucial
Turning to the economic dimension of the situation, the usual policy toolkit to fight recessions may not be very effective in the short run because of the unusual nature of the disturbance. A classic recession involves a shortfall of demand relative to supply. In that more ordinary situation, economic policymakers know how to help fill in the missing demand. But this case is more complicated because it involves negative hits to both supply and demand.
- On the supply side, the spread of the disease—and the measures taken to slow it—has prevented and will continue to prevent workers from showing up at factories, restaurants, and other workplaces where physical presence is still essential. Even manufacturers nowhere near the initial outbreak are being hobbled by their inability to source inputs from plants closer to the epicenter of the disease. Such effects seem to have been limited thus far but may become more severe as inventories are depleted. Everyone is getting a fast lesson that globally interconnected supply chains have their vulnerabilities as well as their virtues.
- On the demand side, waiters who are sent home from empty restaurants won’t earn tip income—which, in turn, will curb their spending on goods and services they would otherwise purchase. Other examples will abound as the slowdown spreads. More generally, fear and uncertainty are sure to dampen both consumer spending and business investment.
The usual tools of monetary policy are ill-suited to correct supply side disruptions. No amount of rate cutting by the Federal Reserve (and there isn't room for much) is going to persuade local officials not to close schools; businesses not to cancel conferences or conventions; or manufacturers to reopen their plants when they are unable to source parts from suppliers that are shuttered. Rate cuts—including the one on March 3—may modestly help in demonstrating that the Fed is on the job. And of course, the Fed will need to monitor carefully that the financial system continues to function well. Over the longer haul, the Fed should expend its firepower aggressively to ensure the speediest possible recovery. But by and large, the near-term problem is not one the Fed can fix.
Even fiscal stimulus may not have much effect in the near term, for the same reasons: A little extra cash in the pocketbook won’t ease concerns about sending a child to school when the disease is spreading through the community, for example. Nonetheless, it’s essential that the tools of fiscal policy be put to work, especially because the Fed will almost surely run out of ammunition if the slowdown morphs into a full-blown recession. Therefore, Congress and the president should be hard at work now on developing a robust package. (In a PIIE working paper David Reifschneider and I discuss the severe constraints on the Fed’s ability to fight recessions and the steps it should take to restore some of its policymaking potency.)
No one knows how serious the economic damage from COVID-19 will be, so a key challenge is to design a fiscal countermeasure that clicks on when it’s needed and clicks off when it’s not. One approach that would fit that description would be to move immediately to pre-position a temporary cut in the payroll taxes that fund the Social Security and Medicare programs. (Yes, the trust funds should be held harmless by transferring general revenues to make up the difference.) Over the course of a year, a 2‑percentage-point cut in these taxes would put an additional $600 in the pockets of families with a median household income of $60,000. Such a tax cut wouldn’t reach everyone affected by the disease, but it would be far more progressive than a cut in the federal income tax. Progressivity is important because lower-income families will tend to spend a higher fraction of the tax cut’s proceeds.
Given the uncertainty about how serious any economic downturn will be, the tax cut could be wired to click on if the unemployment rate moves up by more than ½ percentage point. If that happens, a full-blown recession will likely be in process, with a much larger rise in unemployment probably in the pipeline. By bolstering confidence, even the promise of added cash in consumers’ pocketbooks—if it’s needed—could help mitigate the severity of the downturn. To ensure the tax break clicks off when it’s no longer needed, it could be set to expire when the unemployment rate crosses back below a threshold value written into law. Given the low level of unemployment that now appears to be consistent with stable inflation, a threshold in the neighborhood of 5 percent would make sense as a starting point for conversation.
Other approaches are certainly possible. For example, the US Treasury could alternatively send every person who paid Social Security and Medicare taxes in 2019 a flat amount—say, $600. Again, this move could be triggered by a sufficiently large increase in the unemployment rate. This approach would have the advantage of funneling the fiscal resources down the economic ladder to a slightly greater extent; and there is some evidence that consumers will spend a larger fraction of the proceeds if they are delivered in the form of a one-time payment rather than dribbled out over time.
Speed is of the essence
Whatever approach is taken, speed is of the essence, and the two approaches outlined here are familiar entries in the fiscal playbook. The United States can get them right with a high degree of confidence and get some cash out the door quickly, when it’s needed. Moreover, the basic triggering mechanism could be left in place permanently, providing a positive legacy in the form of strengthened automatic fiscal stabilizers.
If school closures do become widespread, it would be important to replace the school-provided meals that so many students and their families depend on. In 2016–17, slightly more than half of all students nationwide were eligible for free or reduced-price lunches. At the same time, the unemployment insurance program could be fortified, and other steps could be taken to strengthen the social safety net.
Today, in the face of a highly probable downturn, action beats no action. A medical cure for the disease may be long in coming. Now is the time to put in place the economic and social therapies that probably will be needed.
1. Claudia Sahm has observed that since 1970, every time when the three-month moving average of the unemployment rate is ½ percentage point or more above its lowest value in the prior 12 months, the economy has been in recession.