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Up Front

How does the coronavirus pandemic compare to the Great Recession, and what should fiscal policy do now?

How does this episode differ from the Great Recession of 2007-09?

The underlying cause of the economic slowdown—and possible recession—likely in coming quarters is fundamentally different from that of the Great Recession. The Great Recession was a result of financial imbalances—starting primarily in the housing sector. This one is from a totally external factor, the coronavirus disease (COVID-19).

Why is that important?

It is possible that this downturn will be a lot shorter and shallower than the Great Recession. It may be V-shaped—perhaps negative growth for a quarter or two, followed by a period of strong growth. In the Great Recession, in contrast, there were fundamental imbalances that had to be worked off.

Nonetheless, these are very early days and there is a huge amount of uncertainty. We don’t know how bad the health effects from the virus will be or how long they will last, how many countries will be affected and to what degree, what kinds of disruptions to production might ensue, whether the economy will spiral down if this lasts a long time, etc. It is worth remembering that in the early days of the housing market downturn, many of us thought that the problems would be limited to the subprime mortgage market and wouldn’t be macroeconomically important. We were very wrong.

For government economic policymakers, there is another big difference. In 2008, some worried that remedies such as mortgage relief or bailing out the banks would encourage people to make and take riskier loans in the future, confident that the federal government would bail them out if things went wrong. Moral hazard is simply not a concern now; no one will wish for a virus in the future in the hopes of getting some government aid.

What lessons did we learn from the Great Recession?

The post-2008 focus on promoting financial stability has left us in better shape to weather a downturn. Banks have much more capital than they did before, and the Federal Reserve and other financial regulators have learned how to step quickly to ensure that credit markets function smoothly.

Hopefully, we also learned that economic downturns are very costly, and that fiscal stimulus (spending increases and tax cuts) can cushion the blows to households and businesses. In hindsight, most analysts wish the 2009 $800 billion stimulus package had been larger, not smaller.

What should fiscal policy do now?

With interest rates extremely low—inflation-adjusted, or real, interest rates are negative—there is little cost to borrowing heavily and doing what turns out to be too much. On the other hand, there is a tremendous cost to underestimating the extent of the problem and doing too little. We need to err on the side of doing more rather than less. This is especially true now because the Fed—which helped stabilize the economy in the Great Recession—has much less room now with the benchmark federal funds rate before any hint of the coronavirus at just 1½ percent. In 2007, the federal funds rate was 5¼ percent, so the Fed had a lot more room to cut.

What principles should fiscal policymakers use?

Do whatever it takes to minimize the health costs of this pandemic.

That means making increased COVID-19 testing a national priority. That also means making sure that infected people stay away from the general public, which involves paid sick leave (paid either by employers or, if necessary, by the government) so that they don’t show up for work, free testing and treatment for those with the virus, and making sure that the undocumented do not fear showing up at a health facility.

Address the costs of the near-term downturn.

At a minimum, economic activity in the second quarter is likely to fall. We need to make sure that people are protected from the loss of income—think of the Uber and Lyft drivers, florists, cruise crew, hotel maids who may be out of work. We should do things like expand unemployment insurance benefits to those otherwise ineligible, increase SNAP benefits so low-income families can afford food even if they aren’t getting paychecks or their children aren’t getting free meals at school. We should also follow the suggestions of Jason Furman, the former chair of the Council of Economic Advisers, who has proposed sending checks to households: $1,000 per family and an additional $500 per child. This will help people who are hurt by the downturn, and also provide some support for the economy even after the virus threat recedes. (And this is smarter than a payroll tax cut, as my colleague Jay Shambaugh argues.)

Prepare for the possibility of a far deeper, more protracted downturn.

Congress should enact now programs that will automatically kick in if the unemployment rate increases without the need for any additional legislation or Congressional-White House haggling. One particularly attractive proposal (see this proposal by my colleague Matt Fiedler and coauthors) is to raise the federal share of Medicaid spending, the health insurance program for the poor that is jointly funded by the federal and state governments. We know that states and localities will be on the front lines of the crisis, and that their balanced budget requirements mean that any increases in spending coming from the crisis, and any reductions in tax revenues from the downturn, will turn into cutbacks into future years. An enhanced federal match is an efficient way of getting money to states to prevent these cuts. We might also consider a host of other programs that would be triggered if unemployment rises, perhaps another round of checks to households or increased unemployment-insurance checks. And the legislation could be written so the extra benefits trigger off automatically once the crisis passes and unemployment falls.

What about the federal debt?

Yes, the federal debt is large by historical standards, and it is projected to keep rising. But interest rates are also at historic lows, meaning that debt is not costly. The federal government can borrow for 10 years at an interest rate of just 0.87 percent as I write this. In any case, the fiscal policies I am advocating are one-time policies that will end when the need for fiscal stimulus is over. They won’t have much effect on the long-run trajectory of the debt, which is driven largely by population aging and rising health costs. Insuring the economy against a significant downturn is a better way to boost living standards than pinching pennies in the face of a crisis.

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