Trying to directly assist individual firms is a fool’s errand. Monetary policy is approaching its limits. We need to look to bigger, aggressive action, writes former Reserve Bank economist Michael Reddell.
The economic implications of the Covid-19 public health emergency are formidable, and are growing by the day.
Most of what we’ve seen in New Zealand so far relates to the epidemic stemming from China and the steps taken to get things under control. Much of the policy discussion, including recent comments from the minister of finance, seems to have focused on attempts to assist firms and individuals in sectors which directly affected.
But that approach risks being a big mistake. It might have been fine if the only material outbreaks of the virus had been in China, and once they got things under control it was only a matter of time – albeit perhaps months – until those specific sectors and firms can get back to normal. But that simply isn’t what we face. Only yesterday the Italian government quarantined one of the major industrial regions of Europe.
Public health experts tell us the virus can be checked, but only with expensive and disruptive restrictions – voluntary or imposed, here or abroad. In her latest column here, Siouxsie Wiles notes:
Another thing we are all going to need to start doing soon is minimising or avoiding contact with other people. This is called social distancing. If you are greeting people, don’t hug, shake hands, hongi, or kiss. Bump elbows or feet instead. Work from home if you can. Much as it pains me to say it, social distancing also means avoiding public transport (get on your bicycle!). Similarly, it means avoiding gyms, churches, cinemas, concerts, and other events and places where people congregate.
Already, airlines report that forward bookings have dropped away sharply, and foreign tourism is heading towards zero for a time. It won’t be the only severely adversely affected industry, and the effects will be felt widely.
Economic policy needs to be focused not primarily on the limited and concentrated economic disruption we’ve already seen. Instead, ministers and officials need to focus on the much, much larger, but scale-uncertain, losses and disruption that will soon break on us, and on vulnerable individuals rather than firms. As importantly, we need to be positioning ourselves to ensure that when the epidemic passes – and that could be some time – we are positioned to get overall demand and economic activity back towards normal as soon as possible.
Much of the economic loss and disruption we are near-certain to face over the next few months is now all but unavoidable. Nothing we do will put tourists back on plane, or open up supply lines from Milan, or whereever the next place to clamp down severely is. When people choose to stay home and maintain those distances, spending and economic activity will drop. It is the price we will pay as governments here and in other countries seek to spread out and reduce the incidence of the virus itself, and as individuals seek to limit our personal risks.
Trying to directly assist individual firms is a fool’s errand. We just don’t know what we will be dealing with just a few weeks from now. Very soon the number of firms that can plausibly claim adverse effects will be huge. We simply don’t have the capacity to administer complex tailored schemes for huge numbers of firms, and the way would inevitably open up to all sorts of rorts and abuse.
That is why we have macroeconomic policy tools, which are designed to operate pretty pervasively when activity across the economy is hard-hit.
Monetary policy is typically the main one. The Reserve Bank is already quite badly behind the game in not having cut interest rates. No doubt they will do so later this month, but they need to cut the OCR hard, and to err on the side of what might look like doing too much. The risks of actually doing too much are slight, and the risks to falling short are substantial. Among them is a risk that expectations about future inflation drop materially further, which would raise real interest rates in the face of this severe and complex shock, greatly complicating the eventual recovery.
But monetary policy is approaching its limits. This is one of those (quite rare) times when monetary policy really needs to be supported by a significant and, when activated, fast-working boost from fiscal policy.
Big infrastructure projects are largely beside the point here – they simply take too long to get under way. One-off cash payments to households probably also aren’t the right thing, at least now. In the next few months people will be hunkering down anyway, and as I’ve already noted, a key consideration is providing support and confidence as and when the worst of the virus – and attendant direct economic disruption – has begun to pass. One possible tool, as part of a package, would be a significant, explicitly temporary, cut in the rate of GST.
Such a cut could be implemented quickly, would put more cash directly in the pockets of households, would operate in a somewhat progressive way (poor households spend a larger share of this year’s income than upper-income households) and explicitly encourages people to buy early rather than later (because you know prices will be rising again in, say, 18 months hence when the GST rate goes back up again).
The key point now is that the government has to be looking forward, not backwards, and acting in ways that take seriously the sheer scale of the costs and dislocations we are just about to face. Whatever New Zealand does, we can’t avoid many of the short-term costs that are coming, but we can do a little to mitigate the damage (in an environment like this, for example, retail interest rates probably should be near zero, which they aren’t now) and official actions now can help create a climate most supportive of an eventual recovery. We need people to be confident of aggressive action focused on the real issues. In these circumstances, there are few or no returns to half-measures.