The coronavirus is rewriting the economic rulebook

The crisis caused by the coronavirus has upended conventional economic thinking. This is evident in several different ways.

One is the role played by economic policymakers. Central banks have responded by pushing monetary policy to the limits. Last week brought the news that the Fed will massively step up its programme of asset purchases. In addition to purchasing government bonds and mortgage-backed securities, it will also buy corporate debt and issue loans directly to firms for the first time ever. The scale is unprecedented – in the past two weeks it has bought 5% of the entire market. Just as the 2008 financial crisis caused the old rules of monetary policy to be torn up, the same is happening in this crisis (though to be fair to our Chief US Economist, Paul Ashworth, he did anticipate that corporate bond purchases could be the next tool to be deployed). Helicopter money could come next.

Meanwhile, the role of governments is being rethought. The scale of fiscal support that has been deployed is – rightly – huge. One of the legacies of this crisis will be higher debt burdens, but now is not the time to worry about this. The immediate priority is to cushion the collapse in demand.

In addition to the scale of fiscal stimulus, governments are taking a much more active role in the economy. In the UK, large tracts of the railways have been temporarily nationalised. Support for the airlines in the UK and elsewhere may soon follow. Government guarantees for loans and subsidies for jobs have expanded on a vast scale. The state has emerged as the spender of last resort and the backstop to banks and otherwise solvent firms. In the background, the spirit of individualism that has prevailed for the past thirty years is being supplanted by a new spirit of collectivism. Public health is, after all, the ultimate public good.

Finally, the virus has changed how economists think about the potential scale, speed and spread of economic downturns. The immediate fall in output has been far larger than anything experienced in recent recessions, including the global financial crisis in 2008.

The impact on individual sectors has also diverged from the usual form. We tend to think of manufacturing as being more cyclical than services and therefore being hit harder in economic downturns. This reflects the fact that spending on manufactured products – durable goods, machinery and equipment and so – sits at the more discretionary end of the spectrum and demand weakness is amplified by the inventory cycle. In contrast, spending on many (though not all) services is less discretionary and tends to suffer less.

However, the efforts to stem the spread of the virus has turned that logic on its head. The service sector seems to be bearing the brunt of the economic disruption – in part because it is more labour intensive and thus more affected by the restrictions being placed on the movement of people.

One lesson for the future is that we should resist the temptation to view new economic shocks through the prism of previous shocks. For example, a future shock caused by a technological outage or cyber-shock would look very different from a typical downturn and, much like the coronavirus, could come out of nowhere.

All of this raises big economic and political questions that will need to be answered once the virus fades. Will the size of the state shrink as the crisis eases or will it be permanently larger as demands for spending on public health and crisis preparedness – as well as support for a more interventionist approach more generally – grow? If so, how will that be funded?

How will countries tackle the increase in debt burdens that will inevitably follow in the wake of the crisis? Will they embrace a further bout of austerity? Or will they adopt other measures, such as financial repression, or resort to inflating it away?

And how will the experience of the virus play into the pushback against globalisation that has been steadily building over the past year or so? Does multilateralism have a future? After all, while the scale of the policy response has been huge, the lack of co-ordination between countries has been striking, particularly compared to 2008. More fundamentally, will the virus strengthen the hand of nationalists and isolationists that call for strong borders?

The road ahead is unusually uncertain. What we can be sure of at this stage is that the slump in output over the coming months will be huge – and the virus will leave a complex set of questions in its wake. We will, of course, have more to say about these as events unfold.

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