The world’s economic fortunes have never witnessed such a rapid deterioration. But without fiscal support, the effects of coronavirus lockdowns would be much worse.

Doing nothing would likely have resulted in many more bankruptcies and mass unemployment, leading to persistently lower incomes.

Economic lockdown is expensive. The good news is that governments can currently raise funds relatively cheaply to allow companies to go into hibernation and workers to be furloughed until the virus is brought under control.

It is a price worth paying – a better long-term option than standing by idly while the economy collapses.

A near-term fiscal stimulus preserves the economic institutions that will provide future growth and tax revenues, allowing the stimulus to be reversed and debt ratios to fall. ‘Doing nothing’ may keep debt lower initially, but it ends up much higher in the long run.

In truth, ‘stimulus’ is the wrong word. Government cannot ‘stimulate’ an economy where many activities are banned. Transferring funds to otherwise-bankrupt companies and otherwise-unemployed workers is really the equivalent of an insurance pay-out, compensating their losses.

It is, however, a gamble. If many companies do eventually fail and furloughed workers ultimately lose their jobs, the ensuing economic ‘scarring’ could profoundly alter the fiscal arithmetic, even if the ‘stimulus’ is reversed in 2021.

And a second recession this decade with additional fiscal stimulus would send government debt in many countries towards 150 per cent of GDP. In the UK, government debt typically exceeds that level only during major wars.

After World War II the biggest drivers of declining debt were rapid economic growth, relatively high inflation and unusually low interest rates on government borrowing. So nominal growth generated tax revenues sufficient to pay the interest with cash to spare for additional state spending or debt repayment.

But while circumstances were very favourable after World War II, apart from low interest rates, virtually everything else is unfavourable today: growth and inflation are undershooting, globalisation may reverse, and government debt is already high following the global financial crisis.

With austerity in many countries now a dirty word, the only choices appear to be higher inflation, defaulting on debt, or higher taxes. Income tax financed the Napoleonic Wars: now wealth, pensions and corporations look like obvious tax targets.

Someone must eventually pay for the lockdown costs of a pandemic that has led to far greater economic damage than was imaginable just a few months ago.

First published 1 June 2020.

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