Let me begin by framing this essay with what is obvious: we, and the world, are in a highly fluid situation. With COVID-19 intensifying in the U.S., there has been clamoring for Washington to take action to protect the economy. The Federal Reserve (Fed) has just cut interest rates again (March 15). President Trump’s economics team has floated the idea of payroll tax cuts. To many, these responses seem wholly inadequate and in many respects they are. Tax cuts and lowering interest rates will not stop the spread of this still-mysterious disease. Nor will they do much, if anything, to ease the supply interruptions created by COVID-19’s economic havoc thus far. Such actions would help, however, if the virus endures and precipitates a classic economic retrenchment. In that case, the present and contemplated policy moves will look wise.
The immediate futility of such policy measures is evident in the nature of today’s economic fallout. The disease’s spread has kept workers from their work, not only those who are sick but also the far greater number who worry and have been warned about contagion. In reaction, much of daily activity in the country has been curtailed, including public school systems, universities, sports events, restaurants, museums, theaters, concert halls and more. Output has slowed in China and increasingly across the world.
China’s problems are among the most pronounced. It is where COVID-19 got its start and remains most severe. Statistics are scarce. Most telling is the release by China’s purchasing managers of February statistics. Their index of production, in which the value of 50 delineates the line between expansion and contraction, showed a drop of more than 20 percent, falling from 51.1 in January to 40.3 in February. The manufacturing subsector fell to a low of 35.7.
Problems, of course, have extended beyond China. That country’s quarantines have cut off the huge and lucrative flow of moneyed Chinese tourists to Japan, South Korea, North America, and Europe. And producers in these and other countries have found it increasingly difficult to get needed supplies and parts from China. Apple, for instance, sources many of its products there. The United Auto Workers recently hinted that General Motors may have to close some of its plants because of a lack of parts, and it appears that some 125 prescription medicines in the United States will be unavailable because of a lack of China-based ingredients. As the virus has spread to Europe and North America, cutbacks in travel and work have repeated the Chinese problem and added to supply and parts pressures elsewhere in the world. Neither interest rate cuts nor tax cuts can do anything to address these matters.
- Lower rates might otherwise encourage borrowing for capital investment and expansion, but it is highly unlikely that businesses will invest or expand when concerns about contagion are otherwise idling existing facilities.
- Tax cuts might otherwise increase take-home pay and thus induce people to work and spend more, but it is questionable how effective such policies would be if people are afraid of catching the virus and managers are telling existing workers to stay home.
- And neither action will restart the flow of tourists from China or its shipments of parts and supplies.
Tax and interest rate cuts only can help in the case of classic recessions, which involve a drop in demand for goods and services. The problem today is a shortage of supplies, parts, and workers. Should, optimistically speaking, COVID-19 run its course relatively quickly, as SARS and MERS and other similar pandemics did earlier, people would soon return to work, supply chains would resume functioning, and economies would soon rebound, which is what happened in the case of past viral outbreaks. In such an environment, lower interest rates and lower taxes would do little to accelerate the process and would be useless, except perhaps to calm nerves.
But this does not mean that the policies already implemented or contemplated have no purpose. There is no guarantee that COVID-19 will follow past patterns. If it persists, continuing supply shortfalls and bottlenecks will generate layoffs (of which there already is evidence) instead of pauses and work-at-home arrangements, leading to a drop in consumer spending. Supply problems of long duration would lead to other and more permanent cutbacks, including bankruptcies, which would compound the shortfalls in demand and would bring on a classic recession (of which there already is some evidence). In these circumstances, the demand stimulus of interest rate cuts and tax cuts could perform important counteracting roles, and such stimulus actions would look prescient in retrospect.
It hardly matters whether policy-makers in Washington are thinking about this longer-term possibility or are simply trying to calm nerves by “doing something.” The interest rate cuts announced by the Federal Reserve on March 15 and earlier in the month, as well as ongoing tax cut considerations, though they may look inept in light of immediate problems, would nonetheless position the U.S. to deal forcefully if the world, in its efforts to combat COVID-19, doesn’t have the relative luck it had with SARS, MERS, Ebola, and other outbreaks.