The COVID-19 virus and its impact on public life is the conversation of the day and will likely remain the conversation for many days to come. Where the corona outbreak is in the first place a public health crisis, it has not in the last place also an adverse economic impact. You do not need an Economics degree to understand that quarantine measures directly paralyze the real economy (goods market). Production is halted, firms have to lay-off employee’s or might even go bankrupt. Consequently, private consumption and investment shrink, further accelerating this process. Firms that go bankrupt, default on their loans, consequently financial institutions also find themselves under pressure. Banks become more reluctant to (re)finance firms. The initial shock spills over in the financial system.
The first figures from the US are in, and they are not mild. Over the week from 16 March to 22 March, 3.28 million Americans filed claims for unemployment. From 281.000 the week before this new is figure reflects a 3 million or 1067.6% increase over the span of one week! Large US banks estimates a decline in second quarter GDP growth between 12.8% and 30.1%. Bulland, the head of the Federal Reserve Bank of St. Louis predicted unemployment rates may even hit 30 per cent, accompanying an unprecedented 50% drop in GDP in the second quarter.
Not surprisingly, the Federal Reserve and the US government will do everything to mitigate this adverse shock. The Fed lowered its key rate (fed. funds rate) back to zero by March 15 and committed to purchase $700 billion of US treasury bonds, mortgage-backed-securities (MBS’s) and corporate securities (debt).
But as monetary policy is largely exhausted since the great recession of 2008, fiscal stimulus would have to do the bulk of the job this time. Luckily the US government is determined to react fiercely. Last week the US senate passed a bill, containing $2 trillion worth of fiscal stimulus programmes. Consequently, the Congressional Budget Office projected a $1.1 trillion deficit this fiscal year, or 4.9 percent of US GDP. Several analysists at credit rating agencies expect this figure to be closer to 12%. These estimates vary that much, as GDP itself is a guessing game at this point in time.
The figure below depicts the composition of this stimulus package. A rough 500 billion will be dedicated to loans and assistance of large enterprises affected by the virus, while small businesses can receive 377 billion in loans & grants. Firms can also expect unconditional tax-cuts, but firms applying for emergency credit do have to protect workers and prevent lay-offs.
Interestingly there will also be direct payments (so-called helicopter money) to household up to $1,200 per individual ($500 per child), the level of payment however decreases as income raises. This emergency credit for firms, as well as direct payments to household is the temporary support needed to lower the risk of these actors defaulting during this adverse shock. And hopefully preventing the economy getting caught in a downward spiral.
By: Joris Hoefnagel