Someday the Covid-19 pandemic will probably be history. Nothing is certain: epidemiologists’ ignorance rivals that of economists, and it is possible that Sars-Cov-2 may turn out to be an endemic virus that returns periodically. Either way, the fiscal bill will have to be paid. It cannot be magicked away by modern monetary theory.
Advanced economies have loosened the fiscal and monetary reins most spectacularly — because they could. Under current legislation, the US federal deficit will almost quadruple this year to $3.8tn, equivalent to 19 per cent of gross domestic product. In 2021, it will be $2.1tn, more than the previous 2009 record. Federal debt held by the public will meanwhile exceed 100 per cent of GDP by the end of this year. In 2023 it will rise to 106 per cent, eclipsing the previous record reached after the second world war.
Still, with Congressional Democrats pushing for another $3tn of fiscal programmes, both the US federal deficit and debt stock could rise significantly more over the next few years.
How will all of this be paid for? After the second world war, significantly higher real economic growth and higher inflation, combined with financial repression, did most of the job. Today, higher real trend growth — once the immediate cyclical downturn is reversed — won’t come to the rescue. Global growth will probably be lower after the pandemic subsides.
Even if there is no wholesale move towards further deglobalisation and protectionism, the organisation of production and trade will emphasise planned redundancy. Just-in-time economics will give way to just-in-case economics, with multiple supply chains to ensure continuity in another crisis.
What about inflation? A rise to 5 per cent might mimic the pattern after the second world war. But I see no appetite for that kind of inflation anywhere among advanced economies.
At the same time, the extraordinarily low interest rates we have seen over the past decade could help achieve fiscal sustainability in those economies — a role played by financial repression and inflation after the war. But it would be reckless to bet on that.
No government should expect real interest rates to remain persistently below the growth rate of real GDP. Indeed, forecast imbalances in planned global savings and investment could see real interest rates rise. The decline in Chinese gross saving rates since 2010 reminds us that ageing societies save a lot, but old societies don’t. And as planned savings fall, interest rates rise.
Meanwhile, confidence that governments will be able to monetise massive budget deficits without ever boosting inflationary pressure gets us to the wonderland of modern monetary theory, where fiscal bills never need to be paid. Hope for that, but don’t count on it.
This brings us to the painful ways to restore fiscal sustainability. National treasuries and central banks have acquired significant claims on the private sector during the pandemic. I expect many of these bonds and loans to be written off or converted into nearly valueless public sector equity claims.
That leaves the familiar tools of public spending cuts and higher taxes. Whether tax hikes or spending cuts are favoured will vary from country to country. Advanced economies already differ widely as to how they spend or tax. To use some illustrative OECD data, Ireland’s general government spent the equivalent of 25 per cent of GDP in 2018, while the US spent 38 per cent. At the other end of the spectrum, France spent 56 per cent.
The range is staggering. These differences no doubt reflect some profound differences in political institutions and culture. Still, it surely must be easier for Ireland to restore fiscal sanity by raising taxes than by cutting public spending, while the opposite applies to France.
As for the US, the pandemic has exposed the rotten foundations of its welfare state. Almost half the populationhas health insurance tied to employment. Instead, universal healthcare should be available as a fundamental right to all.
Gaps in unemployment insurance and delays in processing claims have also caused hardship. There have been multiple other failures to protect the weak, the vulnerable and the unlucky. The US cannot handle these challenges with existing fiscal resources. So public spending must rise, with corresponding larger increases in taxes.
I believe many advanced economies will exit the pandemic with profoundly altered political systems. This week, almost 3m Americans applied for jobless benefits; the total number since lockdown began is nearly 37m. The unemployment rate is likely to surpass 20 per cent in May, even as official numbers probably understate those involuntarily idle or working part-time. Huge resources have been thrown to workers, households and companies. But the burden of economic pain is being distributed highly unequally and regressively.
The US may be ready, at last, for a radical overhaul of its tax system, including more progressive income, wealth and inheritance taxes. Before the pandemic, I reviewed Thomas Piketty’s magnum opus Capital and Ideology. I did not think then that the political climate existed for a redistributive and more progressive tax and public spending system. Today I am not so sure.
The writer, former chief economist at Citi, is a visiting professor at Columbia University
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