Coronavirus’s economic policy challenge

At a time of crisis, economic policymakers are well advised to hope for the best but to plan for the worst. This advice could not be more apt than now, when the coronavirus epidemic threatens the U.S. and global economic recoveries.

It also could not be more pertinent than now, at a time when there is not much ammunition left in the traditional monetary and fiscal policy arsenal to respond to a major coronavirus-induced world economic slump. It is better to plan now for unorthodox and coordinated economic policy action as needed before a real economic crisis takes hold than it is to be caught scrambling when it might be too late.

Judging by President Trump’s pronouncements, it would seem that the administration is hoping that the coronavirus epidemic will prove to be short-lived. Never mind that there is now the clearest of evidence that the epidemic is spreading at a rapid pace to every corner of the globe, including to the United States and to countries that have underdeveloped public health systems. Never mind too that the number of new cases outside of China now exceeds the number in China.

The Trump administration keeps reassuring us how strong the U.S. economy is and how resistant it will prove to be to the epidemic. By so doing, it appears to be grossly underestimating the severity of the coronavirus shock to the global economy and how vulnerable the U.S. is to a setback in the world economy.

The truth is that the coronavirus epidemic is simultaneously dealing the global economy with a supply shock, a demand shock and a financial market shock.

The supply shock is coming in the form of the need to quarantine millions of workers, the serious disruption to international supply chains and the major dislocation to transport systems. The demand shock is coming as a result of heightened household and investor uncertainty about the economic outlook that is holding back spending decisions.

Meanwhile, the financial market shock is coming in the form of sharp declines in global stock market prices on the back of diminished corporate earnings expectations. It is also coming in the form of a sharp rise in corporate borrowing costs as investors dial back on their risk tolerance for fear of rising default rates.

Unfortunately, there is not much that economic policymakers can do to deal with the coronavirus supply shock. Interest rate cuts or a fiscal stimulus are not going to prevent the Chinese government’s decision to confine 150 million of its citizens to their homes from decimating Chinese industrial production. Nor is it going to prevent disruptions in the Chinese supply of components from causing large production problems for Apple and for the world’s automobile producers. It is also not going to prevent the coronavirus related fear of traveling from dealing a major body blow to Italy, whose economy relies so heavily on tourist revenues.

While there might be little that economic policymakers can do to prevent the coronavirus supply shock from impacting their economies, there is in principle much that they can do to prevent that supply shock from leading to an undue contraction in demand and from creating a doom loop in the financial markets.

The trouble, though, is that economic policymakers are running out of traditional policy instruments to support demand and to calm financial markets. After this week’s interest rate cut, the Federal Reserve’s policy rate is down to 1 percent, leaving little room for further interest rate cuts. Meanwhile, as a result of the 2017 corporate tax cut, the U.S. budget deficit has ballooned to 5 percent of GDP for as far as the eye can see, which limits the scope for further fiscal policy measures.

In these circumstances, it would not be too early for economic policymakers to be thinking outside of the box as to what else they might do to support demand and calm the financial markets. In this context they might do well to revisit Milton Friedman’s idea of “helicopter money.” The basic idea is to have the Federal Reserve and other major central banks finance on the easiest of terms government cash handouts to that part of the public most likely to spend that handout. An important advantage of helicopter money over, say, yet another round of quantitative easing is that it would support the economy without distorting the credit markets.

At a time of a global economic crisis, it is most effective if the world’s policymakers coordinate their economic policy responses. Lacking international leadership from the Trump administration, I am not holding my breath for that to happen.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging-market economic strategist at Salomon Smith Barney.