News analysis

Virus upends orthodox economics

Public debt now seen as lifeline as leaders channel cash through large fiscal packages

NEW YORK • In the heat of a global crisis more sudden and severe than anything in living memory, economic orthodoxies are being tossed aside at a furious pace. Some of them may be gone for good.

Public debt, for example, has often been seen as a drag on economies - but right now it is more like a lifeline. The coronavirus has shut down swathes of private business. Whatever their prior views on budget deficits, leaders have been forced to fill that gap by channelling cash to households, businesses and markets.

With government spending helping to steer countries through the pandemic, it may not be easy to turn off the taps afterwards. Politicians will have little incentive for belt-tightening measures that could endanger a rebound. Economists, especially from the rising Modern Monetary Theory (MMT) school, will argue that in a low-inflation world there is no need to try.

Even when the acute phase of the health crisis has passed, "political pressures for large fiscal stimulus to be deployed whenever possible will remain strong and open-ended", says Mr Stephen Jen, who runs hedge fund and advisory firm Eurizon SLJ Capital.

That is what happened to monetary policy after the last crisis in 2008, he points out, with central banks still struggling to remove their unconventional stimulus more than a decade later. For the few parts of the developed world, such as the United States, that managed to move away from emergency settings, the pandemic has sent them crashing back there.

In the low-rates era, governments are already the biggest borrowers. Now they are about to go into overdrive.

The US is poised to smash records with a fiscal package worth about US$2 trillion (S$2.9 trillion) making its way through Congress, and lawmakers expect more measures to follow. Other governments, when measured against the size of their economies, are not far behind. The European Union and its powerhouse Germany have ditched once-sacred spending caps. The British government has pledged to cover 80 per cent of the wage bill for workers whose jobs are at risk because lockdowns have shuttered entire industries. Countries from South Korea to Australia have torn up their budget plans and pivoted to more spending.

Many economists say that even more fiscal firepower may be needed, because it will not be possible to assess the full extent of economic damage until the virus is contained. Once that happens, support for the spending bonanza may be tested - on the markets, and in politics.

The surge in supply of government bonds is likely to push yields higher, though central-bank buying can keep a lid on them. That is already an explicit goal of the Bank of Japan, and other countries are set to follow.

In the US, investors may rethink the risks lurking in the longest-duration bonds - but that is likely a problem for down the road, with much of the initial burst of borrowing set to be financed by short-term paper.


Governments may also face political pressure to unwind their largesse, and at least some economists are likely to join in.

In the crisis moment, there has been a shift among even conservative economists, and they have united behind "rapid and large fiscal stimulus", says Dr Adam Posen, who heads the Peterson Institute for International Economics in Washington.

"Whether that is an ongoing turning point remains to be seen," he says. "If we see a recovery, God willing in months, people will want to turn off the taps."

Germany, for one, signalled this week that it aims to return to its customary frugal stance, though officials acknowledged further stimulus may be needed first, if the economy is stuck in a deep slump after the public health emergency has abated. A pickup in inflation - a risk given the pandemic has shut down so much production - could also make conditions tougher for the borrowers.


But there is an alternative post-virus future in which politicians are reluctant to balance the books - and some economists question whether it makes sense to even try.

ING chief international economist James Knightley cites the US case as an example: "I really cannot see (President) Donald Trump, assuming he gets re-elected, embarking on an austerity drive to get the fiscal position on a sounder footing."

For progressive Democrats too, the fiscal debate "should have changed forever", according to Nobel Prize-winning economist Joseph Stiglitz. After Mr Trump's trillion-dollar deficits, it will be hard to make the case that "somehow we can't afford healthcare and education", he says. "That argument is going to look very different."

It is in this scenario that the once-strict dividing lines between fiscal and monetary policy, already looking a bit blurry of late, are likely to get even more so. "There could be pressure to come up with a plan to see central banks cancel a proportion of government debts around the world," says Mr Knightley. "There will be more calls for these sorts of extreme measures."

While deficits and debt have surged to much higher levels during major wars, Deutsche Bank strategists found that public-debt-to-gross domestic product ratios "as a median across the major developed economies" are currently at peace-time records.

Since 2008, central banks have been buying more of that debt, while ultra-low rates made it easier for the governments to keep borrowing. The coronavirus has accelerated their purchases to a new level.


The transactions typically occur in secondary bond markets, allowing monetary policymakers to claim they are not directly financing deficit-spending - a traditional taboo in policy circles. It is one that serves no useful purpose, according to MMT.

MMTers think the traditional fear of budget deficits is overblown. Governments that borrow in their own currencies cannot go broke, their argument goes, so they can spend provided inflation remains subdued - and there is no reason why central banks should not finance them.

That is a recipe for over-spending, according to the mainstream of modern economics. The consensus for decades has been that central banks should be independent from budget-setting governments, and thus able to rein them in. Mr Jen says that tide may be turning, and "large fiscal deficits fully underwritten by central banks" are likely to become the new normal.

"Whether intentional or not, we are collectively moving towards MMT."


A version of this article appeared in the print edition of The Straits Times on March 27, 2020, with the headline 'Virus upends orthodox economics'. Print Edition | Subscribe