Global economy risks another Great Depression

University of Michigan economics professor Justin Wolfers contends that the US economy is probably already in recession due to the coronavirus pandemic. He says that unless governments around the world take ‘drastic actions’ to contain the virus, the economic downturn could be as bad as the Great Depression, when the unemployment rate reached 25% in countries such as the US. Wolfers suggests that the US government should provide the unemployed and under-employed with cash payments and offer loans to small businesses. He adds that tax cuts would not stimulate economy activity quickly enough:

Major American cities such as New York, Los Angeles and Washington have essentially gone into lockdown by ordering schools, bars, gyms restaurants and cinemas to close their doors…

“There are reasons to think this could be as bad as the Great Depression if we don’t get the response right,” Wolfers, a member of the US Congressional Budget Office’s panel of economic advisers…

“Aggregate demand is falling off a cliff; we need to bring out an aggregate demand bazooka. We need to get cash into people’s hands”…

Wolfers said the US government should deliver cash payments to unemployed and under-employed workers as well as loans to small businesses to help keep them afloat until the outbreak is under control…

Wolfers said that while the Australian government had acted quickly on an economic stimulus package, it was now lagging behind other countries’ social distancing efforts.

“People back home need to wake the f— up and get ahead of this,” he said.

“The belief in Australian exceptionalism is absurd and is not being born out by the experience of any other country.”

Martin Wolf chimes it too:

Above all, a depression threatens. Many households and businesses are likely to run out of money soon. Even in wealthy countries, a large proportion of the population has next to no cash reserves. The private sector — above all the non-financial corporate sector — has also gorged itself on indebtedness.

…As lenders of last resort, the central banks must ensure liquidity by keeping the cost of borrowing low and financing credit supply, both directly and indirectly. But central banks cannot deliver solvency. They cannot underpin household incomes or insure businesses against this collapse in demand. As borrowers and spenders of last resort, governments can and must do so.

Long-term government debt is so cheap that they need feel no fear of doing so, either: Germany, Japan, France and the UK are now able to borrow for 30 years at a nominal rate of less than 1 per cent, Canada at 1.3 per cent and the US at 1.4 per cent.

This, then, is a time-limited crisis, with economic and health consequences that governments must manage. Domestically, the bare minimum is generous sick pay and unemployment insurance, including to freelance workers, for the period of the crisis. If this is too difficult, governments can just send everybody a cheque.

As lenders of last resort, the central banks must ensure liquidity by keeping the cost of borrowing low and financing credit supply, both directly and indirectly. Financial Times

Yet even this will not be enough if the costs of mass bankruptcy and a depression are to be avoided. Emmanuel Saez and Gabriel Zucman of Berkeley argue that: “The most direct way to provide . . . insurance is to have the government act as a buyer of last resort. If the government fully replaces the demand that evaporates, each business can keep paying its workers and maintain its capital stock, as if it was operating . . . as usual.” Anatole Kaletsky of Gavekal has recommended a similar response.

Governments the world over need to backstop their economies by providing immediate income support to both households and businesses. Traditional stimulus can come later once the virus has passed and economies enter the recovery stage.

For Australia, the most pressing issue is immediately lifting Newstart by $95 dollars a week (as proposed by ACOSS) and loosening eligibility criteria. This would provide a vital social safety net that protects the many people that will lose their jobs (as well as those unemployed already languishing), in turn providing an automatic stabiliser for the economy that prevents a deeper economic depression.

Don’t worry about going deep into public debt. This is an extraordinary event and the debt can be funded anyway via quantitative easing from the RBA.

The alternative is to do nothing and risk a complete economic meltdown and depression.

Leith van Onselen

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