Policymakers and Coronavirus: Why More Stimulus is On the Way
Author: David Stonehouse
March 30, 2020
This is not the Great Recession all over again.
That’s been the steady refrain of many investors over the past month as the reality of the coronavirus pandemic has gripped financial markets and rattled the real economy. And that perspective is understandable.
After all, the previous economic downturn was brought on by a systemic failure of the world financial system, not by a nasty virus that will surely be contained sooner or later. Meanwhile, banks today are much better capitalized than they were in the mid-2000s, and therefore much better equipped to withstand a downturn and maintain their vital economic role. The unwind of the 2007-2009 meltdown took years; this time, the economic recovery might be measured in mere months, and it may be sharp and swift rather than low and slow.
Yet, if that optimistic view suggests policymakers need not concern themselves as much with the coronavirus crisis, investors should think again. Faced with a choice between prioritizing citizens’ physical well-being and keeping the economic lights on, governments have increasingly opted for the former. Locking down swaths of the economy by recommending or imposing isolation has resulted in an almost instantaneous shock, one that is playing out more swiftly and steeply than any other economic event in our lifetimes – including the Great Recession. Second-quarter GDP growth has a high potential to be the lowest on record, with forecasts increasingly coming in at negative double digits.
Legislators have not been alone in responding; monetary policymakers have, too, and in many cases (for example, in the United States) with more speed and apparent urgency than governments have. Those that unlike Europe and Japan still had room to cut interest rates – such as the Bank of Canada, the U.S. Federal Reserve, the Bank of Australia and the Bank of England – have rapidly reduced benchmark rates to zero, or close to it. Critics have pointed out that such moves are unlikely to either assist in efforts to combat the virus or incite greater economic activity. Yet rate cuts are a part of central banks’ broader strategy to provide more liquidity to the economic system; they are a necessary first step in helping the many companies that will desperately need access to credit in the weeks and months to come.
A necessary step, but not sufficient. In isolation, rate-cutting actions are clearly not enough. As market fear has grown, indiscriminate selling of risky assets has ensued, exacerbated by forced selling from overleveraged institutions suffering substantial redemptions. Recognizing that the financial plumbing has become clogged, central banks have followed up by reviving some of the alphabet soup of emergency lending programs from the financial crisis (for example, the U.S. Federal Reserve’s recently revived Term Asset-backed Loan Facility, or TALF, which enhances liquidity in credit markets). The Bank of Canada recently restated its authority to buy up municipal and corporate debt, suggesting that it might be closer to adopting quantitative easing for the first time in its history. In the U.S., meanwhile, the Fed, which had already restarted its QE program early last year, has upped its liquidity efforts with facilities that target purchases not just of government bonds, but also of corporate debt and commercial mortgage-backed securities – the first time it has ever done so. It has also pledged loans to companies, is establishing emergency credit facilities for consumers and small and medium-sized businesses, and will be extending special credit to large employers – moves that could total as much as US$4 trillion.
These monetary policy programs are welcome, as they will go some way to counteract widespread selling in the markets. Yet still more needs to be done. Entire sectors of the economy (such as tourism, travel and hospitality) are being shut down; they will require bailouts. Furthermore, a significant proportion of small businesses and workers have only a few weeks of cash on hand and cannot withstand any shutdown lasting much longer than that. For them, the question is not one of liquidity, but of solvency. To resolve these challenges, monetary policy cannot be enough on its own. An extraordinary amount of fiscal stimulus will be required in the form of direct loans to small businesses and cheques to individuals.
Numerous countries have already embarked on such measures, in some cases of unprecedented size (double digits as a percentage of GDP), including the likes of Italy, Spain, the UK, Australia, Canada and even traditionally austere Germany, to name a few. More recently, the focus has turned to the United States, where Congress recently approved a fiscal package of some US$2 trillion. That ultimately may grow much larger still.
Will such measures be enough? Eventually, yes, as governments have proven to have almost unlimited borrowing power in the post-crisis world, particularly when supported by central bank quantitative easing. In addition, we believe the U.S. Federal Reserve (among others, potentially) is likely to implement yield curve controls, perhaps along the lines of those adopted pre-crisis by the Bank of Japan, to keep long interest rates from rising to the point where borrowing costs hamper the enormous relief effort.
Still, the key question now is whether these actions will be implemented quickly enough to stave off economic disaster for many households. It is very encouraging that these programs have passed into law, yet it takes weeks for them to be put into action, and time is of the essence. The economic damage is already apparent; only moving with prompt and overwhelming force will prevent a more severe outcome. We already have a taste of how far policymakers are willing to go to meet that challenge, and we will not be surprised to see them go even further. So while it might be true that the world will recover more quickly and strongly from the coronavirus crisis than it did from last decade’s financial crisis, one thing is increasingly clear: when it comes to the swiftness and extent of the much-needed fiscal and monetary response, this pandemic is making the policy responses of the Great Recession look small in comparison.
David Stonehouse is Senior Vice-President and Head of North American and Specialty Investments, AGF Investments Inc. He is a regular contributor to AGF Perspectives.
About AGF Management Limited
Founded in 1957, AGF Management Limited (AGF) is an independent and globally diverse asset management firm. AGF brings a disciplined approach to delivering excellence in investment management through its fundamental, quantitative, alternative and high-net-worth businesses focused on providing an exceptional client experience. AGF’s suite of investment solutions extends globally to a wide range of clients, from financial advisors and individual investors to institutional investors including pension plans, corporate plans, sovereign wealth funds and endowments and foundations.
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Written by
David Stonehouse, MBA, CFA®
Senior Vice-President and North American and Specialty Investments
AGF Investments Inc.
