Our weekly Covid-19 and Economic Diplomacy tracker looks at policies that impact the coordination of international governments and central banks, ongoing commentary and analysis, and asks what these turbulent times mean for economic diplomacy.
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The Highlights
- The Trump administration is considering a $1 trillion infrastructure program to stimulate the U.S. economy where, despite recent employment gains, it seems like many job losses may be permanent.
- Negotiations are underway for the European Union’s 750 billion euro recovery fund, which is to be jointly financed by European borrowing. The German government and the European Central Bank (ECB) are also coordinating on a response to the Germany Constitutional Court’s ruling questioning Germany’s participation in the ECB’s bond buying program.
- Emerging markets finances have been under less pressure recently, but may soon become a serious challenge for practitioners of economic diplomacy. Currencies and sovereign debt markets have stabilized, but developing countries still face a $2.5 trillion funding shortfall in the face of rising Covid-19 cases and the economic shock the virus is causing.
U.S. Developments
While analysts agree that the emergency monetary policy actions of the Federal Reserve have helped the economy plod through the Covid-19 crisis, speculation is turning to whether and how the government will extend its multi-trillion fiscal stimulus measures. With current measures set to expire in July, Congress remains divided. And recent research shows that upwards of 30% of job losses may become permanent. The Trump administration, meanwhile, is considering a new $1 trillion infrastructure spending plan.
- Jenny Leonard and Josh Wingrove broke the news earlier this week in Bloomberg that the administration is considering a $1 trillion infrastructure program. The funds would be allocated to both traditional infrastructure as well as 5G and rural broadband. President Trump has repeatedly supported infrastructure spending during his presidency, but lawmakers have so far been unable to agree on the terms of a package, including whether an increase in gas tax would help pay for the funds.
- Mary C. Daly, President of the Federal Reserve Bank of San Francisco, had called for similar investments in an address to the National Press Association earlier this week, saying the U.S. needs “fiscal policy makers to commit to sustained investments in our economic future.” Daly emphasized infrastructure related to public health during the current crisis, as well as expanding internet access and digital infrastructure.
- Olivia Rockeman and Jill Ward at Bloomberg highlight recent research on the “reallocation shock” that may follow the Covid-19 crisis — that is, jobs that are unlikely to return because of permanent shifts in business and operating models. Bloomberg Economic research estimates that of the U.S. job losses due to Covid-19, 50% are due to the shutdown, 30% from the reallocation shock, and 20% from increased unemployment benefits incentivising workers not to return to their jobs. Losses from reallocation are likely highest in the hospitality, retail, leisure, education and health sectors. The situation could only get worse, the authors say, as companies rethink their business models in a post-virus economy.
- The Bloomberg report follows research by Professors Jose Maria Barrero (ITAM), Nicholas Bloom (Stanford) and Steven J. Davis (Chicago Booth) which estimates that 42% of layoffs during the Covid-19 crisis will result in permanent job losses. The authors note, however, that “the longer it takes to bring the economy back on line, the larger the fraction of recent layoffs that will turn out to be permanent.” That leads them to conclude that some policies that seek to maintain pre-Covid employment will be inefficient if they inhibit reallocation, akin to propping up insolvent firms. Better to focus on efforts to support a timely and efficient reallocation of resources and workers to firms that will thrive in a post-Covid world.
- Professors Jason Furman (Harvard), Glenn Hubbard (Columbia), Melissa S. Kearney (University of Maryland) and former Treasury secretary Timothy Geithner write in the Washington Post about their proposed plan for economic recovery. It includes four parts: income support for unemployed and underemployed (calibrated to state-specific unemployment); benefits for low-wage workers; loans for small businesses; and funding support for local and state governments. The authors estimate their plan would add 4% to GDP over the next 18 months, and 4.5 million jobs.
Officials from the Federal Reserve, including Chairman Jerome Powell, offered their takes on the current state of the economy and toolkit the Fed might or might not consider using should the crisis worsen. The Fed has also begun buying individual corporate bonds as part of its emergency response measures.
- Federal Reserve Chair Jerome Powell, in testimony before the Senate banking committee, warned that despite better-than-expected economic data on jobs and retail sales, “levels of output and employment remain far below their pre-pandemic levels, and significant uncertainty remains about the timing and strength of the recovery.” He also repeatedly encouraged Congress to enact further fiscal stimulus to address near-term economic pain and aid in the recovery.
- The Federal Reserve announced it would begin buying corporate bonds in the secondary market under its Secondary Market Corporate Credit Facility (SMCCF). Notably, the Fed will create an index of bonds that meet its requirements (debt of U.S. companies which were investment-grade on March 22nd, with maturity less than five years), rather than asking companies to “self-certify.” Although the Fed has been buying bond ETFs under the program already, the new actions mark the first time it will purchase individual assets.
- Dallas Fed President Robert Kaplan, in a discussion at Money Marketeers of NYU, shared his views on the Fed adopting yield curve control to push down longer-term rates. Under such a policy, the Fed would buy longer dated U.S. Treasuries in unlimited quantities to push yields down to a target rate. Kaplan said while he wouldn’t rule the policy out, he worried about creating distortions in financial markets. “I’d have to see evidence that there is a reason to do it,” Kaplan said. (See our briefing from two weeks ago for more on yield curve control.)
European Developments
Following an agreement between France and Germany, the European Union has announced a proposal to raise a 750 billion euro recovery fund, financed by joint E.U. borrowing. The plan signals a significant step towards integration. It still needs to be agreed upon by all member states, but German Chancellor Angela Merkel expressed confidence an agreement could be reached by July. The leaders of Austria, Denmark, the Netherlands and Sweden, who oppose the deal in its current form, have begun staking out their negotiating position. Meanwhile, the European Central Bank (ECB) and the German government have begun working on a response to the ruling by the German Constitutional Court which challenged Germany’s participation in the ECB’s sovereign bond buying scheme to support the eurozone economies.
- Arne Delfs and Viktoria Dendrinou write in Bloomberg that German Chancellor Angela Merkel believes a deal on the 750 billion euro E.U. recovery fund is possible by July. In a move towards closer E.U. integration, the recovery program would be funded by joint E.U. debt, but requires the approval of all member state governments. The program includes both an expected 500 billion euros of grants and 250 billion euros of concessionary loans, meant primarily for those countries such as Spain and Italy which are struggling with the economic fallout of the virus.
- The leaders of the Frugal Four nations — Prime Ministers Stefan Lofven of Sweden, Mette Frederiksen of Denmark and Mark Rutte of the Netherlands and Chancellor Sebastian Kurz of Austria — which oppose the current recovery fund proposal, lay out their position in an op-ed for the Financial Times. While reaffirming their support for a “joint road to recovery” financed by joint borrowing, they argue that funds should instead be disbursed as loans to those countries in need. Money spent, they note, will have to be paid back by the taxpayer. Nonetheless, they resolve that “a compromise will be found that makes Europe greener, stronger and more resilient, while strengthening member states’ economies and making the union fit for the future.”
- David Marsh and Danae Kyriakopoulou write at Official Monetary and Financial Institutions Forum (OMFIF), an independent think tank, with updates on how Germany and the European Central Bank are responding to the German Constitutional Court’s ruling which threatened to ban the Bundesbank, Germany’s central bank, from participating in government bond purchases. The court’s decision required the German government to ensure the “proportionality” of the policy. Germany and the ECB are close to a resolution, the authors write, saying “a lifting of legal uncertainty over ECB government bond purchases, accompanied by a big boost in German fiscal activism, forms part of markedly improved European policy coordination spurred by the coronavirus crisis.”
- Writing in the Italian newspaper Il Sole 24 Ore, Sergio Fabbrini, visiting professor at the Harvard Kennedy School, tackles the broader question of what Europe looks like in a post-Covid world, as the global multilateralism Europe thrived in is increasingly replaced by great power competition. “The EU cannot become a great power,” Fabbrini says, “but neither can it become the prey of great powers.” Despite overtures from leaders calling for closer integration in fiscal, military and defense matters, progress has been halting. But the future calls for “EU military sovereignty, limited but independent from its member states” alongside fiscal integration.
- The Bank of England today said it would increase bond purchases under its quantitative easing program by 100 billion pounds, and left it’s benchmark rate unchanged at 0.1%.
Emerging Market Developments
Emerging markets look likely to be a growing economic diplomacy challenge for global policymakers. Although the initial phase of the crisis has subsided, and some developing countries have issued new sovereign debt, analysts are increasingly sounding the alarm about the $2.5 trillion shortfall the IMF expects those countries to face in the wake of Covid-19. With only $1 trillion in IMF lending capacity, and developing countries’ reluctance to participate in debt forbearance programs that may risk their bond ratings, analysts are exploring alternative options for global cooperation to address the longer-term shortfall.
- Andrés Velasco, former finance minister of Chile and Dean of the School of Public Policy at the London School of Economics, warns that if emerging market economies crash, “then rich-country citizens will also be the victims of an economic catastrophe long foretold and clearly avoidable.” He characterizes the recent bond issuances in emerging markets as “households drawing on their credit lines to have cash on hand during the coming storm.” Although debt forgiveness is a good first step, what emerging markets need is new funding to fight the virus and protect their economies. The IMF’s firepower is insufficient to fill the entire funding gap. Velasco proposes two options: the developed world’s central banks lend to emerging markets through the IMF; or, a special-purpose vehicle to fund emerging markets set up by the IMF and World Bank that issues bonds to central banks.
- The Financial Times editorial board points out a growing trend of emerging markets using quantitative easing policies — once seen as only viable in the developed world — to stimulate their economies. Those policies are viable primarily in countries with adequate domestic pools of capital to draw on. But, the writers caution, it is critical to “maintain domestic investors’ faith that the national debt will not be inflated away,” lest investors withdraw from the country, push down the value of the currency and ultimately exacerbate the economic shock.
- David M. Beasley, Executive Director of the United Nations World Food Programme, warns of the coming hunger crisis in Foreign Affairs. Conflict has been the biggest factor driving up the number of people living in acute or chronic hunger in recent years, but Covid-19 will significantly compound recent trends, especially through disruptions in food supply chains. 45 countries may experience famine. WFP research also shows hunger increases cross-border migration. Funding hunger-prevention policies, Beasley argues, is even more critical as a result. And he points to U.S. funding for WFP, which rose from $2 billion to $3 billion in the past few years, as an example.
Odds and Ends
