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Jan Svejnar: The World Economy in the Post-Pandemic Era: Challenges and Responses

DATE: 2020-09-28

        I would like us to talk about government policies and their response to the current economic recession and focusing on the United States and Europe. As you know, the United States and Europe represent about 45% of the world economy measured by GDP and together with China, they are the largest economic blocks in the world. So they are very important, you obviously know quite a lot about China. And so what I'll try to do is supplemented with remarks that relate to the European Union and the United States. There are a number of similarities and also a number of differences, both between the US and the European policies, but also within the United States and within Europe. So I'll try to cover all of these grounds.

        Let me start by saying that there is a considerable legacy, different approaches to economic policy. From the crisis of 12 years ago, the 2008, 2009 economic crisis, the US pursued quite substantive and fast reforms, and European Union went more slowly. The result was that the US recovery was faster and achieved a higher growth rate than the European economy on average. That's good to remember as the background to the current situation. Now at the beginning of 2020, the world economy was subjected to a major shock with the covid-19 virus. There were different degrees of when it was recognized, different reactions and different locations. For instance, in the United States, the New York city area recognized the shock relatively late and went through a very grueling adjustment that we all followed. In Europe, Italy, similarly was much more affected than some other regions. There was this diversity that's really important to recognize right from the beginning.

        Now the effect was a very rapid and deep decline in the gross domestic product everywhere, in fact, in many cases, unprecedented in modern history. When we look at it in the first two quarters, GDP decline in most countries, somewhere between 8% and 12%, although there were others that were subject to deeper declines as well. And both in the individual United States and the EU countries, there were different reactions, and there was relatively little coordination until very recently. The important thing to realize is that what was created was huge uncertainty, enormous uncertainty and also big government intervention, together with the central bank creating liquidity. So the Central Bank started buying government debt, both the central government and the local government, and this rise in debt was accompanied by very low and sometimes zero or even negative interest rates. So the central banks gradually are becoming managers of government debt, which has been increasing considerably over this period of time. Now, the central banks, both in the United States and Europe, have also been buying corporate debt, which is unusual and very new phenomenon. So they started essentially financing the private sector directly, the survival of private sector firms. So the commercial banks are assuming somewhat of our lesser role as a result because the government is stepping in. So what we see is the importance of central bank financing together with the shadow banks, the various other forms of finance. So in some sense, we can say that the central banks are becoming the capital market makers of the last resort, correct? The last feature that I think is important to take into account as we are considering government policies and the evolution is that there's been very low inflation. This is something that's a phenomenon that's been with us for a while now, couple decades. So it is not related to the current shock, but it makes the government policies that we've been talking about and we'll be talking about feasible. So that's important.

        So let me talk a little bit about the United States and a bit about Europe, then we can sum it up and open up for discussion. So in the United States very deep decline in economic activity, and the estimate is that the decline for the whole year will be around 6 to 7%, hoping that there is going to be some recovery in the second half of the year now The important thing is that the US economy, unemployment is a big indicator of the size of the shock because firms lay off workers relatively easily. So unemployment shot up to 15% at one point and still expected to be in the high single digits by the end of this year. There's been a major fiscal expansion which was coordinated congress and the White House. There is a need for another package which has not been yet agreed to. There's been support for firms in terms of providing liquidity loans. Firms have been receiving employment subsidies as well, which is unusual in the United States, but it happened. There's been support for the unemployed workers. So the normal unemployment benefits more than doubled. They went from weekly employment benefit of $450 to $1050, major temporary measures to help the workers make it during the recession and be able to look for new jobs. And so this has been featured that the realm has been unprecedented. Though the first package was large, was with partisan support. Second one has not yet been agreed, as I mentioned. And there's a big discussion in congress of how it should look, how large it should be. And here, the differences between the two parties, democrats and republicans, are substantial and the agreement has not have been reached. But everybody agrees that some further government intervention is very much needed to restart the economy. Get it go ahead.

        Ok, let me talk a little bit about the Federal Reserve Bank, because its role has been very important. It had positive interest rates, which is brought down to essentially zero. And that has been flooding the market with liquidity, buying bonds of firms, state and local governments, as I mentioned. And this, by the way, actually, this liquidity translated into the stock market after falling temporarily, coming back. So actually the stock market level is relatively high despite the decline in the real economy. And it's been because the Federal Reserve Bank has provided so much liquidity, some of which found its way into the stock market. Recently, the Federal Reserve Bank has announced what's called a dovish policy a new long term strategy, which will focus on stimulating employment. The Federal Reserve Bank in the United States has a mandate to both focus on price stability, but also generating employment and economic growth. And what the fed has been signaling is that it's not worried so much about inflation. It's willing to permit, in the short run, some inflation at the expense, because it tries to stimulate employment. Okay, so it will not be, for instance, raising interest rates when there will be some inflationary pressures, as it normally would, in order to permit expansion, economic expansion, and employment to increase.

        Now when you look at Europe, the European countries, you realize that much more has been done at the national level. You basically have national government policies, the Germans for Germany, French for France, and so on. So this gives, of course, the rise to diversity of policies that we see there. We also see in all the countries, major fiscal expansion stimulated the economy. But in most countries, it's less than what we observed in the United States. So it's more limited or has been more limited. The emphasis has been on preventing a rapid rise in unemployment. So, in Europe, there always has been emphasis on controlling for rapid rise of unemployment. And indeed, in most European countries, unemployment has not risen anywhere near as high as in the United States. It's done by subsidizing firms to keep workers on their payrolls so the workers may be underemployed. But they stay with the firm. So one doesn't shatter, doesn't destroy the link between the firms and workers, so that during the upturns, the firms can start utilizing workers fully. And there isn't this problem of trying to hire workers and not finding the right type of workers. So this has been relatively successful. There is an indication that, in fact, this is a system that may be installed more generally. For most countries, it's so far it's been more generally established in Germany and Austria. And it may be in other countries as well.

        Now there's been a very major change in July 2020. So a couple months ago, where Europe, European Union leaders as a whole agreed to, in fact, provide an EU-wide approach to the crisis by establishing the so called recovery and resilience fund. It was brought together by the two main leaders on the continent, Emmanuel Macron of France and Chancellor Merkel in Germany. And they agreed that there would be a common European Union debt instrument. The European Union as a whole, rather than individual countries, would borrow and provide the funds to stimulate individual economies mostly in the form of grants. And the large part would go to the weaker economies in south like Italy and Spain first. Ok, so this is a very important change, historical change leading to greater federalization of Europe, common policy in this area. Now, the European Central Bank, which covers the countries in Europe that have a common currency, the euro, has also used the approach similar to the federal reserve bank in the United States, but more limited. And more limited in the following way: It never had positive interest rates in recent history. It was already at zero. And some rates were even negative. So it didn't have the latitude of decreasing interest rates and stimulating the economy that way. But it certainly has started buying, in a larger way, debt, again, both government debt and of individual institutions and firms. So in that sense, it was a similar approach, but less pronounced than what we have observed in the United States.

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