The Developed World’s Policy Conundrum after the Covid-19 Crisis

On the 11th of March of 2020, as the World Health Organization announced that Covid-19 could be classified as a pandemic, governments and central banks all over the world had gradually begun to fathom the social and economic disruption that the spread of the virus could generate. They understood that their policies would have to strike a balance between protecting public health, minimising socioeconomic damage, and respecting human rights. This was not going to be an easy task, not least because of the infrastructural, economic and socio-political unpreparedness of most nations for the global public health emergency that Covid-19 would engender. 

By the end of March 2020 the virus had spread to over 100 countries, and most governments had imposed very strict public health measures designed to suppress its transmission. Global economic activity was brought to a standstill, aggregate demand deteriorated, many businesses were forced to close, and unemployment soared. The G20, a group of the world’s 20 largest economies, experienced a 9.1% contraction in its gross domestic product (GDP) in the second quarter of 2020, compared to the previous year[1], dwarfing the 2% year-on-year GDP contraction that was endured in the second quarter of 2009, at the height of the Global Financial Crisis (GFC)[2].

Faced with this dire economic situation, and in contrast to the previous decade of public spending cuts in the pursuit of balanced public budgets following the GFC of 2008-9, governments and central banks across the developed world deployed an unprecedented degree of fiscal and monetary support to their economies and financial markets. The fiscal stance of governments metamorphosed into being about doing “whatever it takes” to minimise the long-term damage to the economy and ensure a swift economic recovery. They acted promptly and forcefully, so that by June 2020 over $10 trillion in fiscal stimulus had been announced – with developed economies accounting for the lion’s share of this[3]. The Coronavirus Aid, Relief and Economic Security (CARES) Act, passed in the United States (US) in March 2020, was the largest of these fiscal interventions, mounting to an estimated total size of $2.3 trillion, or 11% of US GDP[4].

In a similar fashion, monetary authorities deployed all their policy tools at hand to inject liquidity into their economies and support financial systems. By April 2020 all central banks in advanced countries had cut, or maintained, their policy rates to near-zero levels, and launched new lending operations and asset purchase programmes[5]. In the Eurozone, for example, where negative interest rates had rendered the conventional monetary policy tools ineffective, the European Central Bank (ECB) introduced the Pandemic Emergency Purchase Programme (PEPP) in March 2020, a temporary asset purchase programme worth €750 billion[6].

In hindsight, it is generally agreed that the policies were successful. While most, if not all, economies experienced their worst economic downturns in recent history, they also experienced their shortest recessions on record. Compared to emerging markets and developing economies, who are expected to remain under their pre-pandemic output paths in the near future, the world’s advanced economies are expected to return to their pre-pandemic output levels by 2022[7]. The downside, however, is that this has come at a cost. The $16.9 trillion that governments spent to fight the pandemic are expiring, and world public debt has stabilised at around 100% of GDP[8]. The balance sheets of the Federal Reserve and the ECB have skyrocketed to $8.5[9] and €8.2[10] trillion, respectively. Both still purchase billions worth of financial assets on a monthly basis. And interest rates are at all-time lows. 

The focus now is on whether the monetary and fiscal authorities should reduce their presence in the economy by withdrawing the pandemic support. Some stress that this could slow the economic recovery that is underway, especially at a time when new Covid-19 variants and global supply chain disruptions threaten to do much of the same. Equally, others point to the inflationary pressures that continuing the spending could precipitate, while also warning that the authorities and economy have been left deeply unprepared for another economic crisis and future disruption. 

It is clear that a middle way will have to be found between withdrawing the policies implemented during the Covid-19 Crisis and supporting the economic recovery. Once again, this will be no easy task, but it is one that cannot be avoided.

  3. McKinsey

Author: Alisha

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