COVID-19 is a health emergency on an unprecedented scale, causing both a supply and demand shock to the economy.
Just as the economic consequences haven’t been witnessed before the measures announced by Central Banks and Governments have not been implemented before.
The targeted policy measures introduced by Central Banks and Governments across the world share some similarity but the devil is in the detail with some differentiation across countries. Along with interest rate cuts delivered by Central Banks, Governments have predominantly taken action in the form of fiscal spending i.e. tax cuts, grants and holidays to help businesses survive the COVID-19 storm.
It is still too early to assess whether these measures are the right ones, but it is imperative that the policies are targeted and implemented in phases, just as the easing of lockdowns are being phased.
Phase 1: Survival
With strict lockdown measures implemented in order to save lives it was inevitable economic activity will curtail. During this phase the role of policy should not have been to stimulate aggregate demand but instead policies needed to prevent excessive economic disruption. Safeguarding policies to help those most vulnerable, minimising the loss of jobs and ensuring businesses avoid bankruptcy.
The UK Government delivered, announcing measures to help the low-income earners, measures for homeowners, renters and vulnerable businesses. The measures were also complemented by the actions of the Bank of England. But these measures cannot be sustained for a prolonged period of time. As the UK begins to ease lockdown measures the Government will be contemplating on withdrawing some of these measures. The question will then be how and when these measures are eased and what should the UK Government do next.
Phase 2: Stimulate
As restrictions are lifted and the economy starts to return to some form of normality, the success of the pace of recovery will be dependent on policies undertaken during this phase. This is the most important of all phases.
There are two ways for stimulating the economy: expansionary monetary policy and expansionary fiscal policy. It is proven that in the short-term increases in government spending are much more effective in stimulating the economy than are tax reductions. Tax cuts are much more effective over the long-term. The UK risks falling behind its continental rivals when it comes to energy, transport and telecoms. This would be a good time to push ahead with major spending plans such as infrastructure spending. The yields on long-term along with three-year and five-year government bonds are at record low levels. It makes sense for the Government to make the most of the low rates and finance debt with the longest possible maturities. As the economy then begins to recover the multiplier effect will come into play whereby an incremental amount of spending will provide employment opportunities, increases in income and therefore consumer spending. As the economy embarks on its growth trajectory, government debt ratios will stabilise in favourable debt dynamics.
The UK will need to ensure its efforts to stimulate the economy not only reflect the current drivers of economic growth but also anticipate the structural shifts that COVID-19 would have caused. Expansionary monetary measures during this phase should include ensuring banks are lending and interest rates are kept low, providing the much-needed liquidity.
Phase 3: Sustain
During this final phase, it will be vital to promote and foster innovation in order to strengthen the long-term potential of the economy as well as recover the suppressed supply by improving the economy’s productive potential.
One way to do this would be to implement policies that address the inequality across the UK by raising the living standards. The COVID-19 crisis has exacerbated inequalities across the UK. Government intervention through the tax and benefits system as well as investment in education will promote greater economic mobility and reduce inequality.
Furthermore, it will become increasingly important that future economic growth is environmental sustainable. This will be critical to the long-term sustainability of the economy.
While there is no optimal fiscal or monetary package, measures need to be timely, targeted and tailored to the specific phase. The right policies at the right time will ensure the economy recovers from this much quicker and sets its path for higher trending growth.
