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How the Covid-19 recession could become a depression

Coronavirus is a global economic catastrophe.

Trading on Wall Street was temporarily halted on March 9, 2020, as US stocks joined a global rout.
Timothy A. Clary/AFP/Getty Images

As the Covid-19 pandemic worsens, it’s hard to decide which are scarier: the conversations I’m having with epidemiologists or the conversations I’m having with economists.

“This is an economic tsunami,” Mark Zandi, chief economist at Moody’s Analytics, told me. Social distancing is economic distancing. We are telling people to cease going to stores, to restaurants, to workplaces. We are insisting they stop supplying their labor, making their goods. To slow a pandemic, we are forcing a recession, perhaps a depression.

It was common, in 2008, to hear economists say that nothing had changed in the real economy. The US still had just as many workers, factories, and machines. We hadn’t lost any land or knowledge. There was no physical reason the economy was in crisis. The collapse in credit markets had changed economic behavior — businesses were afraid to invest and hire, and families were afraid or unable to spend.

What we had was an “output gap” — the difference between what the economy could produce and what it was producing. The solution to an output gap, particularly one caused by collapsing economic demand, is simple: fill it with money. Invest in infrastructure projects. Give families cash. If corporations and consumers won’t spend, then the government should spend on their behalf, creating the economic demand necessary to push the economy back to normalcy.

The mistake the US made in 2008 was not spending enough. We underestimated the size of the output gap, and then passed a stimulus too small to fill it. When the Obama administration returned to Congress for more fiscal ammunition, Republicans refused, and the recovery limped rather than roared. This is recent history, and in ways both implicit and explicit, it’s shadowing the immediate response to this crisis.

Trading on the NYSE floor will temporarily become fully electronic to protect employees from spreading the coronavirus.
Spencer Platt/Getty Images

But this is not 2008, when the economy was intact but the credit markets were frozen. The real economy is in shambles. Millions of workers are being forced to shelter in place, and the factories and machines they operate are lying quiet. We are losing the use of land and knowledge, because the clusters of human beings necessary to build on them could spread a deadly disease.

As Jason Furman, who served as deputy director of the National Economic Council during the financial crisis, put it to me, this isn’t a financial crisis, where if you can stop the panic, you can unfreeze the economy. “Here, there’s a deadly germ out there and you don’t want to go near it for your sake and your community’s sake. There’s only one equilibrium: It’s economic inactivity until the danger passes.”

The coming waves of economic pain

“We’re about to see dizzying decline in economic activity,” says Zandi, the Moody’s economist. “There’s no analogue to it in the modern era.” It’s a shocking statement, coming barely a decade after a global financial crisis that was, supposedly, our generation’s great economic flood. But Zandi thinks what’s coming now may prove much worse.

There will be at least four waves of economic pain, he told me, each building on the last. Wave one is “the sudden stop,” the unexpected cessation of economic activity all across the country. A month ago, people were going to work, eating in restaurants, paying child care workers, buying flights, planning car purchases, looking at new homes, growing workforces, holding conferences. Now, vast swaths of the country are sheltering in place, and much of the economy has simply ... stopped.

On Friday, Goldman Sachs projected gross domestic product (or GDP, a measure of the size of the economy) would fall at a 24 percent rate in the second quarter of the year. If you’re unused to looking at GDP numbers, I don’t know how to convey how startling that forecast is. “A decline of this magnitude would be nearly two-and-a-half times the size of the largest quarterly decline in the history of the modern GDP statistics,” they write.

When the economy stops, and GDP plummets, workers lose their jobs. That, Zandi said, is wave two, and “it’s coming very quickly.” It may already be here. Initial data suggests we’re seeing a spike in unemployment claims so massive it makes the worst week of the Great Recession essentially disappear on a chart.

Chart showing unemployment claims across the decades. Christina Animashaun/Vox

As my colleague Matthew Yglesias writes, “the surge is so unprecedented in historical terms that it essentially defies efforts to forecast where the economy may go in the future.” Treasury Secretary Steven Mnuchin warned of 20 percent unemployment before walking it back. On Sunday, James Bullard, president of the Federal Reserve Bank of St. Louis, said unemployment could reach 30 percent, and GDP could drop by 50 percent.

The third wave, according to Zandi, will be “all these folks who’ve seen their nest egg wiped out. They thought they were set for retirement and they’re not. They’ll go into panic mode.” The shattered stock market will be a disaster for those in or near retirement. They’re watching wealth they worked their whole lives to build crumble in the space of weeks. They won’t purchase that new car, buy that new house, plan that vacation — and unlike some of the direct economic stoppages, which will lift when the virus eases, their reticence to spend will slow economic growth long after the direct crisis ends.

Wave four, Zandi continues, will see businesses cut investment. Corporations that intended to open a new factory won’t; media organizations thinking of launching new publications will hold back; businesses that meant to upgrade their office space in 2021 will decide they’re fine where they are. Another engine of economic growth dead.

All of that, Zandi said, is “definitely going to happen” — indeed, it’s already happening. But if the virus is brought under control in May, and Congress passes enough stimulus, Zandi and other forecasters think powerful catch-up growth in the third and fourth quarters is possible. Perhaps this could be a “V-shaped” recession: a sharp drop followed by a swift recovery.

The nightmare scenario is that the virus isn’t under control by the summer, and extreme social distancing measures are needed throughout the year — which many public health experts consider likely. Then, Zandi said, the ground could collapse underneath the economy.

One possibility is a chain reaction of failing businesses. If social distancing is extended for months, absent a nationwide bailout, small businesses will collapse. Think of the restaurant industry, which, as Eater writes, “has never seen a crisis on this scale before.” But it’s not just restaurants. It’s virtually every small, low-margin business that relies, in some way or another, on face-to-face interaction. Physical therapists. Hair and nail salons. House cleaners. Plumbers. Gyms.

Big business won’t be spared, either. The airline industry is already begging for bailouts, and anyone whose profits are built on live events is in danger. Ride-hail companies like Uber were burning money before this crisis — will they survive it? How about hotels? Clothing retailers who primarily sell out of stores? And the more businesses that fail, the more firms that were built to serve them will fail.

Another possibility is a financial crisis, in which the markets for corporate debt or government bonds or international currency flows lock up, and create a contagion of their own. Already we’re seeing signs of strain: strange movements in municipal bond markets, shortages of dollars, and corporate debt markets. If any of these collapse into panic, we could add a 2008-style financial crisis atop our 2020-style economic and public health crisis. If that happens, says Zandi, “then you get into very dark scenarios — you start getting three, four, five years of financial pain.”

So what to do?

This isn’t 2008. It’s worse.

Let’s start with a warning: We can’t fight the last recession. This time really is different.

“I feel like we need a new term for the kind of unemployment we’re going to have,” says Christina Romer, the Berkeley economist who led President Obama’s Council of Economic Advisers during the financial crisis. “It’s not cyclical unemployment. It’s quarantine unemployment. Businesses aren’t allowed to operate. People aren’t allowed to be out of their home. The idea that if you just give people money it’ll somehow prevent the unemployment rate from skyrocketing makes no sense. No amount of demand stimulus will get people to go to restaurants if they’re closed.”

As Romer sees it, the problem is twofold. “First, how do you help people make it through this period? The people who’re directly affected need us to take care of them.” That’s where cash grants come in. But the second question, Romer says, is “how do you keep the economy in a position where, when the virus goes away, we can recover quickly? We need to avoid a permanent loss of capital and business knowledge.”

When the virus goes away. This is the scary economic reality we’re in for the foreseeable future: So long as the virus is a live threat, our economies won’t recover because we won’t let them recover.

I want to make certain I’m not misinterpreted on this next point: We need policies to put money in families’ pockets, and we need them now. But we also need to recognize that they won’t be nearly enough. The cash transfers and safety net expansions Washington is considering are exactly the kind of policies we needed more of in 2008. They are necessary now, too, but they are insufficient.

“Only part of what we’re facing is a conventional recession, which can be offset by fiscal and monetary policy,” wrote Paul Krugman, the Nobel Prize-winning economist and New York Times columnist. “The rest of it is more like a natural disaster, where the government’s role is to help families avoid economic hardship, not put them back to work.”

Of the various bills to send cash to families, the best, in my view, is the proposal from Sens. Michael Bennet (D-CO), Cory Booker (D-NJ), and Sherrod Brown (D-OH). It’s generous, targeted, and, crucially, automatic, delivering up to $18,000 to families of four and sustaining the aid so long as the public health emergency continues or unemployment is elevated. It’s precisely the kind of policy Congress should have passed in 2010.

Sen. Cory Booker (D-NJ), left, and Sen. Michael Bennet (D-CO).
Bill Clark/CQ Roll Call

But Bennet prefers not to think of it as stimulus. “It’s an economic support payment,” he says. “We are asking people not to work in order to slow down the spread of the disease. In order to do that, you have got to give them some basic measure of economic security.”

In the immediate term, in other words, this policy has almost the precise opposite intent as the 2008 and 2009 stimulus did. Then we were spending money to close the output gap, to put families back to work immediately. In this case, we’re spending money to make it possible for families to sustain and survive the output gap, until the threat has passed.

Some economists have mused to me that the closest comparison to the economy we’re creating now is the economy of World War II: The government was spending huge amounts of money on the war effort, but wages were suppressed, goods were rationed, the public was pressured into buying bonds, and social norms discouraged excessive consumption. At the moment, the government is, or may be, spending massively to enable social distancing, but even the households that are financially stable will find their opportunities for consumption limited, and public health mandates and social pressure could curb spending for some time to come.

In 2008, economic policy was motivated, albeit imperfectly, by the single question, “How quickly can we get the economy back to normal?” In 2020, we face two questions in conflict with each other. First, how do we stop mass deaths from coronavirus? Second, how can we make sure there’s an economy to come back to, once we can get back to normal?

Only solving the public health problem could wreak havoc on the economy, while focusing solely on keeping the economy humming will wreak havoc on public health. “The ideal policy mix should both lower and raise output, and at just the right speed,” George Mason University economist Tyler Cowen said in a sharp paper. “No one ever taught us how to do that.”

Policies to support families through this nightmare are necessary, and should encompass everything from cash grants to paid leave to massively expanded unemployment insurance to guaranteed health care (the Roosevelt Institute has a thoughtful set of recommendations). But we will also need policies that permit the businesses that employ them to survive.

One hangover from the financial crisis is that bailouts got a bad name, because banks that helped cause the crisis were rescued as part of the effort to limit the damage. That felt, and was, unfair. But the vast majority of the businesses endangered bear no responsibility for the epidemic. Coronavirus wasn’t caused by restaurants or gyms; it didn’t build off the risky trades made by clothing stores or vacation rental companies. If those businesses collapse in mass numbers, then even when the health risks pass, the labor market will be in shambles, as there won’t be jobs for workers to return to.

In the New York Times, Andrew Ross Sorkin has proposed that the government “offer every American business, large and small, and every self-employed — and gig — worker a no-interest ‘bridge loan’ guaranteed for the duration of the crisis to be paid back over a five-year period. The only condition of the loan to businesses would be that companies continue to employ at least 90 percent of their work force at the same wage that they did before the crisis.”

We can argue over structure and details, but this is the scale of policy we’ll need to preserve something like our current economy if the coronavirus crisis extends through the year. The question some economists have raised is whether preservation is even the right goal: A program like this would mean many businesses saddle themselves with debt they can’t pay back and end up going under anyway, but taxpayers take the loss. You can read Cowen articulate some of those worries here.

We may need a different economy on the other side of this crisis, and policies that freeze the current one in place, at large cost, may slow that transition. Yet that transition will be brutal, carrying a vicious human toll, and it’s an open question whether we’d even remain politically stable through it absent a level of social support no one is currently considering.

In a more imaginative country, with a more ambitious and capable political system, crisis could become opportunity: This could be the moment to pass a true Green New Deal, taking advantage of cheap money and idle workers to solve perhaps the central problem of our future. If this economy must collapse, perhaps we could build something better, fairer, more sustainable in its place. “I hope this will cause a seismic political change,” says Sen. Bennet. “I think this is going to make us realize we need to invest again in America.”

Alas, that is not the vision of the political leaders who will be managing this crisis through 2020, though perhaps that will change in 2021.

Related listening

Annie Lowrey and I discuss why Covid-19 “is a shock to the American economy more sudden and severe than anyone alive has ever experienced.” You can listen to the whole discussion by streaming it below, or by subscribing to The Ezra Klein Show wherever you get your podcasts.

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