Much of what passes for normal practice in public finance and monetary affairs seems to have been suspended: unprecedented expansions of spending by governments; open-ended asset purchasing programmes by central banks. What kind of global financial reckoning can we expect to follow when the pandemic has been brought under control? Can the vulnerable be protected? Will the losses and gains that inevitably follow increase the concentration of wealth?
The motivation for the policy actions taken so far has been obvious enough. Avoidance of the kind of financial market panic that occurred at the outbreak of the last crisis in September 2008; paying for increased public health costs; providing protection to those whose income has been hit by the shutdowns; keeping fundamentally sound businesses afloat. Yet most of these financial measures are only stopgaps, like pressing a partially effective pause button in financial affairs.
The actions taken by governments across Europe and in North America to provide partial protection for the incomes of workers and others most affected are already on an unprecedented scale and will probably have to be expanded even more. In designing such measures, each national government has been making its own political judgments on the question of fairness.
Since it is unmatched by tax increases, this spending is resulting in a sharp increase in debt. Instead of falling as was budgeted, the Irish Government’s debt could easily increase by €20 billion or more this year, depending on how long shutdowns continue.
In the last – very different – crisis, the Irish government reached the limits of its access to private financing. This time, we can be less concerned than in the past about the safety of the debt of heavily indebted euro-area governments. This is thanks to the European Central Bank’s recent open-handed decision to expand the scale and scope of its asset-purchase programmes.
Already at historically low levels, the interest rates at which all of these governments can borrow are likely to stay low through this difficult period. At such interest rates the sustainable level of long-term government debt is considerably higher than it was in the past. Even Italy, so often singled out for the high level of its debt, can withstand the additional burden of debt which it must incur if it continues to be able to borrow at less than 2 per cent per annum.
But what about all of that cash created by the central banks in their purchasing programmes? Elementary textbooks say that it will eventually turn into inflation. But that’s not likely today or tomorrow. Anyway, with euro-area inflation having undershot its target for seven years now, a moderate increase in inflation over the coming decade would be no bad thing.
It is a different matter for over-indebted governments in less prosperous parts of the world badly affected by this crisis and less able to cope. With investors fleeing and their currencies depreciating, a standstill on their debt servicing will surely be needed, followed in many cases by a debt restructuring. The International Monetary Fund needs to manage this in a way that protects the ability of governments in low-income countries to protect social services.
Traditional bankruptcy mechanisms cannot speedily cope with the likely extent of small business insolvency
Pandemic losses will also mean that many firms will be unable to repay their debts. Addressing the problem of firm over-indebtedness is the most complex financial and political challenge facing governments. It helps nobody if a fundamentally sound business closes because of financial losses resulting from the shutdown. But the social solidarity which justifies protecting the living standards of workers hardly extends to the bailout of equity and bond investors in medium- and large-scale firms. In order to avoid disruption to the services that they provide, governments will likely take control of some large firms.
Traditional bankruptcy mechanisms cannot speedily cope with the likely extent of small business insolvency. For smaller firms, the banks will play a central role. Last time it was the banks in advanced economies whose incaution led them to be the weakest links in finance and toppled the world into a severe recession, acutely felt in countries such as Ireland where the excesses of banks were most extreme. This time, thanks to tighter regulation, banks are in a somewhat better condition to absorb the inevitable losses in this downturn on some of their existing loan portfolio.
They must facilitate a continuing flow of working capital to their customers during this difficult period. Not only does this imply moratoriums, where needed. In addition, banks should be used as a conduit for funding needed to keep afloat fundamentally sound small businesses that would otherwise be unable to survive the pandemic-related losses.
Such efforts will need to be backstopped as, despite the other supports being given to firms to help them meet workers’ pay during the shutdowns, losses will be incurred on some of the new lending. A programme for sharing the risk between the banks and the public sector needs to be defined. The challenging part of this will be to ensure that public funds are not being diverted to maintaining or entrenching inequalities of wealth.
Ideally the backstop could be at a European level – administered by a European Union institution such as the European Investment Bank – as this is a problem affecting firms throughout the single European market. A common European backstop for meeting the exceptional needs of firms attributable to the pandemic would be a natural candidate for the resources to be raised by a collective liability EU bond. It might escape the usual objections to such bonds inasmuch as it would not be paying for government spending.
Getting the global economy working at full strength again in the months ahead will not be a smooth or trouble-free process. The need for vigorous government action will continue; it cannot prevent financial losses and gains, but governments need to be cognizant of the influence of their policies on the distribution of wealth if an increase in the concentration of economic power is to be avoided.
Patrick Honohan was governor of the Central Bank from 2009 until 2015. He now works at Trinity College Dublin and the Peterson Institute for International Economics