Coronavirus pandemic could be an economic policy turning point, reconfiguring the public-private nexus

The zero-interest rate environment is likely to continue long after the crisis abates and government debt will balloon
Governments will have to make difficult decision on which companies to save, without upsetting the principle of market forces

Tai Hui

Published: 5:00pm, 27 Mar 2020

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When a boxer is forced into a corner by his opponent, he is only thinking about how to get out of that situation. His immediate priority is simply to survive this round. The same applies to governments around the world, which are trying to control the coronavirus pandemic and save lives without wrecking economies. Nonetheless, these necessary short-term actions may leave significant longer-term marks on the policy environment.

First, global interest rates are rapidly collapsing to zero. We started 2020 with policy rates around the world already at a low level. In just the last few weeks, to try to prop up global economies that are sinking rapidly as a result of the global lockdowns, central banks around the world have tried to cushion the blow by easing monetary policy aggressively.

They have already cut policy rates 85 times in total before the first quarter is over, compared with 132 cuts in the whole of 2019. The US Federal Reserve cut its policy rates by a total of 1.5 percentage points to zero in March, a dramatic move in such a short time frame. The Bank of England and the Reserve Bank of Australia also cut their policy rates to all-time lows.

Moreover, these monetary authorities are rolling out fresh rounds of quantitative easing to ensure long-term interest rates stay down too. The Fed is offering to buy as much US government bonds and mortgage-backed securities as needed to stabilise the market. It also rolled out a number of measures to inject liquidity into the corporate bond market and money market funds.

The European Central Bank offered to buy €120 billion euro of assets, followed by pledging an additional €750 billion of asset purchases under the Pandemic Emergency Purchase Programme. The Reserve Bank of Australia has also pledged to use asset purchases to keep the three-year Australian government bond yield at around 0.25 per cent.

Philip Lowe, governor of the Reserve Bank of Australia, speaks during a news conference in Sydney on March 19. Australia's central bank deployed its remaining conventional interest-rate ammunition and will target three-year government bond yields to support an economy spiralling towards its first recession in almost 30 years. Photo: Bloomberg

After the global financial crisis, central banks found it difficult to normalise all these emergency cuts, even once the economy had returned to a better health.

The Fed was only able to start raising interest rates seven years after the global financial crisis, in December 2015, and it was not able to bring policy rates back to a neutral level due to the US-China trade war. This implies the zero-rate environment is likely to stay, maybe long after the pandemic is contained.

Second, government debt is likely to balloon. Developed economies like the United States, Europe and Japan are already running sizeable government debt, as a result of the global financial crisis forcing governments to bail out companies and support the economy.

There are also long-term structural problems with government finances that are pushing government debt higher, such as pension liabilities and costly medical care for the public.

The Covid-19 pandemic is forcing governments to loosen their purse strings once more. There is little doubt that much of the fiscal support, such as providing paid sick leave for workers and helping small and medium-sized enterprises to obtain financing, are the right things to do.

Nonetheless, fiscal deficits will rise enormously in the short term, with higher fiscal debt levels in the long run. Eventually, tougher fiscal reforms or higher taxes will be needed to contain the rising debt burden.

Why the ‘big bazooka’ used during 2008 financial crisis won’t work today

Both the monetary and fiscal stimulus mentioned above are much needed right now. Yet, some of them may have considerable side effects, such as asset price inflation or suppressed income in fixed income assets, and these aggressive actions leave central banks and governments with an even smaller toolbox to deal with future shocks. Authorities may have to come up with ever more creative ways to support their economies.

Federal Reserve chairman Jerome Powell greets then International Monetary Fund managing director Christine Lagarde, now president of the European Central Bank, at the IMF Committee Plenary, during the IMF and World Bank’s 2019 annual meetings of finance ministers and bank governors, in Washington, in October 2019. Both the Fed and the ECB have announced a stepped-up quantitative easing programme. Photo: Reuters

Major events like the Great Depression, or wars, often change how governments provide services to their people. The Covid-19 pandemic could be a policy turning point and escalate these measures into the public agenda, especially when the US is in an election year. It would be difficult to see voters in need of assistance not backing candidates advocating more social support.

This could also extend to the role of governments in the corporate world. It is difficult to see governments allowing companies in strategic sectors, such as airlines, aircraft and car manufacturing, to go under and make millions of workers redundant.

US carmakers received huge government support during the global financial crisis. However, how would governments decide who to save, without upsetting the principle of market forces? 2020 is set to be a historic year where the Covid-19 pandemic could fundamentally change the interaction between governments and their people.

Tai Hui is chief market strategist for the Asia-Pacific at JP Morgan Asset Management

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This article appeared in the South China Morning Post print edition as: Pandemic could mark turning point in global economic policy

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