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Economic stimulus is the wrong solution for now

The government should instead provide liquidity - and give businesses and individuals enough money to survive the shock.

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The Fed should be prepared to make loans readily available to efficient businesses that, because of the crisis, may close their doors permanently.

AFTER several days of intense negotiation, the Senate and the White House have struck a deal to infuse some US$2 trillion into the ailing US economy. While there can be no doubt that swift action is vital, too many politicians and policymakers seem to think the goal should be to stimulate the economy back into action.

In fact, stimulating the economy is the wrong prescription. To combat the spread of Covid-19, we need a period of less business activity and less consumer demand. Instead of stimulus, the government should provide what economists call liquidity - a financial cushion to allow businesses and individuals adversely affected by an inevitable decline in economic activity to have enough money to survive the shock.

In recent days, commentators have compared the economy to a patient in a medically induced coma. In order to stem the spread of the virus, the strategy is to keep people inside, to encourage them to work from home and reduce large group activities, all of which mean slowing the economy down, not speeding it up. More economic activity will be desired down the road, but right now, the most important consideration is ensuring the survival of workers and businesses adversely affected by reduced business activity. This requires that funds be available to provide liquidity.

The Federal Reserve has already begun to do its part by creating facilities, like the Commercial Paper Lending Facility announced on March 17, which will work to stabilise corporate financial markets that have been under stress.

On Monday, Fed chairman Jerome Powell made clear that the central bank would buy as much government debt as necessary, engage in quantitative easing, aggressively buy up commercial paper (that is, debt), and make loans where needed, to guarantee the smooth functioning of the financial markets. These steps are similar to those used in 2008, which showed that the way to end financial panic is to remove its cause - which is, often, a lack of liquidity.

Now it is Congress' turn. Whatever legislation that comes out of the current round of negotiations should be focused on providing short-run support for businesses and individuals during this difficult but temporary period. The most important actions that Congress can take are those that keep businesses and individuals solvent, so that when the crisis period ends, economic structures will be in place to begin a quick recovery. What does that mean? For starters, it means not being overly specific about where the money should be spent.

LEARNING FROM THE PAST

One lesson of the 2008 financial crisis is that it is difficult to anticipate where future disruptions will occur, and therefore where money will be needed. Instead, Congress needs to authorise funds that can be used by the administration as the need arises. Carte blanche authority is admittedly dangerous; funds can be misused. But the downside of a strictly "targeted" approach is worse.

We can identify some of the problem areas right now - for example, airlines - but it is presumptuous to believe that we know which industries will suffer and will need help, even in the near future.

A case in point: In 2008, the Troubled Asset Relief Programme (Tarp), as the name implies, was initially pitched as a programme to buy up toxic assets. But it quickly became obvious that financial firms did not want to sell assets that would force them to mark to market and reduce the stated value of their portfolios. Nor was there enough money in the Tarp to buy up a large-enough fraction of outstanding troubled assets. (The White House agency that I headed at the time, the Council of Economic Advisers, estimated that there were over US$3 trillion in toxic assets, or almost 10 times the size of the first tranche of the Tarp.)

When attempts to buy up toxic assets proved unsuccessful, the Tarp had to be repositioned quickly to purchase preferred shares in financial firms. That was the right approach because it gave the financial sector the capital it needed to withstand the shocks that were to come. Fortunately, flexibility written into the Tarp legislation allowed that shift to occur.

We will need similar flexibility now. In the coming weeks, resources are likely to be needed by large sectors of the economy. Some of this may be a result of the legislation recently passed by the House of Representatives that, among other things, creates a mandate requiring small firms to provide paid sick leave to workers. In return, businesses will be eligible for a refundable tax credit. But even successful small businesses, stressed by declines in activity, might be out of business by the time they collect their tax credits, despite the best efforts by Treasury to get the payments out quickly.

This is why a liquidity-based strategy is so important. The Treasury Department or the Fed should be prepared to make loans readily available to efficient businesses that, because of the crisis, may close their doors permanently absent short-run liquidity to buffer the shock. Loans may be difficult to obtain privately if businesses overwhelm capital markets during this crisis.

But in doing so, Congress should not specify which industries get loans. Right now, the most distressed firms are in travel, leisure and hospitality, but shelter-in-place orders, like those in California and New York, coupled with voluntary restrictions by individuals on shopping and work, will strain many other sectors. It is difficult to foresee in which industries future pressure will be most pronounced.

Workers and their families will also suffer liquidity problems as business activity falls. It is essential to keep them viable as well, and a more aggressive policy of short-term sick pay and unemployment benefits will likely be needed soon. These policies should be designed specifically to get people through this difficult period - not to stimulate them to spend more money.

During typical recessions, the federal government provides funding to lengthen the period over which unemployment benefits can be received. Now the need is to raise the weekly benefits unemployed workers receive, so that they can pay their bills and buy necessities during the crisis.

Additional approaches that work through a firm's payroll were successful in Germany during the 2008 recession. The government made payments to companies that partially covered worker salaries and kept employees on the payroll during periods of reduced demand. We should do the same thing now.

THE IMMEDIATE APPROACH

Payments to specific workers who suffer layoffs or reduced pay is a better approach than providing cash to all Americans. Cheques to give them spending money is actually counterproductive to our efforts to fight the pandemic: We should not be encouraging increased economic activity right now. And in any case, such payments are unlikely to provide much stimulus: Distributions made in the spring of 2008 did little to avert the financial crisis and its effects on the real economy.

When the threat of the virus spread has subsided, stimulus could be considered. The more important and immediate approach should emphasise help for those who suffer pay cuts, providing enough support to tide them over during the difficult period.

Washington should be using every tool at its disposal to support American businesses and citizens economically. But how it does so matters. In a normal recession, monetary and fiscal stimulus might be appropriate. Today, though, our economic policies need to work in concert with our efforts to fight the pandemic. There will be a time for stimulus, but for now, what we need is enough liquidity to help weather the months ahead. NYTIMES

  • The writer is a professor at the Stanford University Graduate School of Business and a Hoover Institution fellow. He served as chairman of the President's Council of Economic Advisers from 2006 to 2009.
  • This article has been updated in the opening line; the original NYTimes version was published before the stimulus package agreement was reached