Co-ordinated macroeconomic policy remains the most effective response to the pandemic economic shock

by Dr Drew Woodhouse, Lecturer in Economics at Sheffield Hallam University

The spread of Covid-19 has shaken people’s lives around the world in an unprecedented way, adversely affecting their health, well-being, ability to work, and linked to this, their income. In response, Governments and central banks have put in place wide-ranging policies to protect people and businesses from the economic shock caused by the pandemic. They have been quick to don an ‘economic life support machine’,  introducing a mix of innovative fiscal measures, unconventional monetary policy and financial ‘stress’ policies. Despite such active policy, the path to economic recovery remains uncertain in the absence of a vaccine or relevant medicinal therapeutics. What is clear is that policymakers are becoming central actors, walking a delicate tightrope between healthcare concerns and the future of our economies. As we debate how economic policy should navigate through future turbulent seas, this blog makes a simulated case for macroeconomic policy coordination.

In modelling the economic impact and recovery, it is prudent to present two equally possible scenarios moving forward; one, the virus recedes slowly and remains controlled, with no renewed national lockdowns (‘single-hit scenario’); and two, a second wave of contagion in late 2020, with renewed national lockdowns (‘double-hit scenario’). In both cases, estimates project a continued decline in output this year, followed by a slow, ‘no-V’ fashioned gradual recovery in 2021, with key short run economic ‘temperature checks’ remaining below the levels of an unchanged long run productive capacity trend.

Policy simulations for the G20 economies based on the calibration of a NiGEM model highlight the benefits of economic policy co-operation. Taken together, these policy measures raise the level of GDP by around 0.75 per cent in the first year (t+1) in the median G20 economy and by 1.2 per cent in the second year (t+2), with the level of output permanently higher in the longer term where the output gap is in equilibrium (Figure 1, Panel A). The near-term boost to output primarily results from the collective gains from more supportive macroeconomic policies, but the structural reform measures also start to raise output in the short run, with their impact continuing to build over time. In practice, it is not clear how there will be a demand for structural change in this short run space.

In panel B, there are clear gains from collective action relative to single country action. There are two main transmission channels for this: one, acting together enhances the demand spillovers through trade growth and higher financial asset prices. Two, there is a boost to global confidence and reduction in perceived uncertainty that comes from collective actions to tackle a common problem that knows no bounds.

Policy coordination would provide the most effective stimulus ‘punch’. Having responded in a largely uncoordinated manner so far, there are compelling reasons for the international community to pull together with a clear agenda that can address the large economic disruptions caused by the Covid-19 outbreak and the challenges that result. These policy scenarios bring into sharp focus the risk of countries turning away from multilateral institutions and global trade under the pretext of self-sufficiency and public health concerns. Health first, economics second and politics last. Leaders must take responsibility to ring-fence our existing network of relations that has brought us together post-Bretton Woods.