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Published onApr 09, 2020

Recessions are not normally thought of as normal. But normal recessions tend to follow a certain pattern. First, they are preceded by a boom — a sustained period of high growth. Second, this boom gives the financial sector the confidence to innovate in various new ways of managing risk. Too often, however, these are not really new innovations per se but, instead — it is not a stretch to suggest — were just new ways of rationalizing the taking of risk and spreading it around. Third, some people start worrying about whether these new innovations are really innovations but are instead just more risk taking. Those worries are often dismissed by the mainstream who point out that, while that may have been the case in the past, this time it really is different and the financial markets have found a party that will last forever. Fourth, something happens which starts to suggest this isn’t a party anymore. Like Wile-E-Coyote, the market realizes they are over a cliff and the party ends in a crash as if gravity is a force that can be defied without self-awareness. And, finally, this leads to a freeze in liquidity — that is, everyone not wanting to do anything but hold onto whatever money they have — which curtails investment, harms the cash flow of businesses, causes bankruptcies and puts people out of work. The end result of this is an economic mess that the government and central banks try to solve by providing liquidity that went missing or spending where others stopped and, after a long period of time (at least for the unemployed), the economy starts up again and there is a boom. Repeat.

Given the regularity of the normal recession narrative, you may wonder how people could think there was something else going on. In hindsight, it all looks like a familiar pattern. At the time, however, there are people who think otherwise. They may class themselves as mavericks who will finally buck an historical trend or it may be that they are a generation who didn’t live through it before nor have taken or paid attention during their Macroeconomics 101 classes. But it is precisely because no one is really sure who believes what that during the actual cycle, there is uncertainty and noise. Indeed, financial markets have confidence issues all of the time and often manage to act like a recession is coming even when it does not emerge. That is, a financial crisis always precedes a recession but there are financial crises that also happen without broader ‘real world’ consequences. Such uncertainty is why governments and central banks can be (somewhat) excused when they don’t quite see a recession coming and perhaps act when it is too late.

The COVID-19 pandemic is a real crisis and not a financial crisis born of years of hubris on the part of relatively few people. Instead, it has elements of a natural disaster and a national holiday. At the time of this writing, the COVID-19 recession is more of the latter than the former and the hope is to keep it that way. Either way, it is very different from previous recessions — we don’t need hindsight to understand what its causes are. We know exactly what happened. Economic activity is falling because of COVID-19, both its (potential) impact and also our policies designed to protect our health from it. From the perspective of economic policy that yielded something unprecedented: virtually all economists — regardless of how confident or not they were in the economic role of the government — agreed on what we had to do about it.1 We needed to ensure that people got paid or, at the very least, continued to act as if they were going to be paid.

Before explaining why this is so, it is useful to reflect on the natural disaster recession that, in many respects, we are trying to avoid. Such recessions have occurred in the past and they are the worst.

Dark Recessions

Economic activity is usually measured by exchange — that is, people pay money for services and things and one person’s purchases becomes another’s pay. The more we do this, the higher our incomes are. Recessions are a reduction in economic activity. As a consequence, we end up with lower incomes and lower expenditure. As expenditures tend to make us more happier than not, our economic well-being is harmed by recessions.

There are two distinct ways that we can see a reduction in economic activity. First, we can decide that we want to spend less on things. If we do that, then businesses find their demand and sales will drop off, they will be less profitable and, not surprisingly, will want to scale back what they do. Fewer payments mean fewer people are paid. Second, something terrible can befall our ability to produce things that people will buy. If that happens then, regardless of how much they may want those things, there will be shortages. If there are fewer people around to be paid, there will be fewer payments. Dark recessions are recessions of the second variety.

Natural disasters are a clear cause of dark recessions. A flood, hurricane or earthquake can hit a region and, in the process, cost lives and also destroy productive assets — in particular, buildings and equipment but also infrastructure. Ultimately, we produce things by supplying capital and labor. Natural disasters reduce the availability of both and depending upon its severity it can take months or years to restore them. If there is a silver lining here, we can ensure people get paid quickly by employing them in the clean-up and rebuilding process. From the perspective of our national accounts, disaster in reality doesn’t always look like a disaster for GDP.

The same loss in productive factors arises after wars. During wars there is another story as resources are reallocated to war efforts. Once again, a situation where a seeming expansion in economic activity underlies a tragedy.

A pandemic has the elements of a natural disaster except that it is purely focused on people. The fear is that a large share of the population will become sick and a relatively large share might die. From an economic perspective, that means that temporarily, and potentially permanently, we will have fewer workers to produce stuff. We will have a recession or worse but without the potential increase in economic activity that might be generated by rebuilding.

The past is some guide to this. The only global, widespread pandemic that has happened during times where we kept some economic data is the Flu of 1918.2 The problem, of course, is that pandemic was hot off the heels of World War I; although it was precisely the end of that war and the returning soldiers that led to it being a global event. This made it hard to disentangle what was due to the war and what was due to the pandemic.

Economists Robert Barro, Jose Ursua and Joanna Weng have looked at the impact of the 1918 influenza pandemic and have calculated that it likely resulted in the deaths of 2 percent of the world’s population over a two year period.3 That put it in a class of disasters akin to the world wars and the Great Depression where there were greater than 10 percent declines in real per capita consumption in an adjacent year. The problem is that it is hard to separate the pandemic from the war.

To tease this out, the economists noted that World War I had different intensities of combat both on and away from their own soil and that there were some differences in how the pandemic spread across countries. They concluded that, in the US, the fatality rate of 0.5 percent likely led to a decrease in GDP of 1.5 percent (2 percent for consumption) but that there was a corresponding decline through 1921 that caused a 6 percent decrease in GDP (7 percent for consumption) in that year alone. In other words, these were declines similar to the Great Recession of 2008-2009.

Could we be facing a dark recession that is worse than this? It is hard to say. On the ‘bright’ side, unlike 1918, most of those becoming seriously ill are not of working age. On the ‘dark’ side, we have more complex and integrated supply chains where an outbreak in a particular workplace or region can cause widespread disruptions. Suffice it to say, even completely ignoring the horrific loss in life and uncertainty, a dark recession is very significant and something we want to work very hard to prevent.

The Recession we ‘Want’

A dark recession could come later. At the beginning of the outbreak, we have policies being enacted that are generating an immediate recession. This is the recession we want so as to prevent the catastrophic outcomes we really don’t want. But that doesn’t mean it isn’t without costs. It is, as former Obama economic advisor, Austan Goolsbee said, a “now problem” that we want to “prevent forever damage.”4

Small businesses are worried about both now and forever. The majority of countries are pursuing social distancing in response to the pandemic and what that means is that those businesses might find that, all of a sudden, their customers have disappeared and with them the payments they make. What hasn’t disappeared are lots of bills. To be sure, if you are a restaurant you can scale back purchases of food and you could also lay off employees. In both cases, there is the specter of supply chain disruption which is what many economic policymakers immediately worried about. But what those businesses cannot do is easily stop paying rent, loan repayments, utilities and other costs that do not vary much (or at all) with customer volume.

Here is what normally happens if a business loses its customers. They scale back expenses and then if it continues, they are unable to pay for those other items and so go out of business. This is part of the ebb and flow of the economy and a reason for businesses to work hard to keep their customers coming. On the other side, there is little tolerance for unpaid bills because those suppliers — say a landlord or a bank — have their own businesses to manage. This is the reason why we measure economic activity by the volume of payments that are made between people in a year (as we do for GDP and its relatives). We are richer when we pay each other more and are poorer otherwise.

This time it really is different. We know exactly why businesses have seen their customers disappear — the pandemic response of social distancing whether enforced or otherwise wants to ensure that people do not congregate even if that is the way economic activity takes place. Moreover, we know that ideally, we want people to go straight back to their economic activity right afterwards. In other words, in a normal recession we don’t want to go back to business as usual because that likely caused the problem. In a pandemic, we do.

This may seem like a tough task, but we should take solace that we choose to have recessions all of the time and it just works out. This may seem like a surprising statement but consider what happens on December 25th in many countries. On that day, economic activity declines at levels that would make the Great Depression seem like a picnic. Apart from some people who would really like Chinese food, this does not appear to have significant economic costs. You may want to work that day or you may want to buy something but you will have difficulty finding others take the other side of that transaction. Hence, payments stop and with it, economic activity.

If we measured GDP changes daily rather than monthly or quarterly this may show up in our economic mindset. The same is true of our weekly recession that occurs in what might ominously be called ‘The Weekend.’ Once again, we appear to agree that no one is transacting as much on Saturdays or Sundays (or Fridays in some places) and even if you want to you cannot engage in some forms of economic activity. It’s a regular recession and one that we appear to want just to give everyone a break.

This is the reason why pandemic-induced social distancing that causes a recession is a little like a national holiday. We have agreed not to engage in economic activity so we should not be surprised when our usual measures of such activity show a decline.

Herein lies our potential mistake — treating this recession like a normal recession when it is not. To be sure, people are not getting paid and resources are lying idle. But that is what makes a recession and not something that is normal. If we layer on the concern that the usual ways of measuring economic activity is sending us bad signals, which is what happens in a normal recession, then we have a problem.5

It shouldn’t be that way. Instead, we have to do what we do on the weekend and holidays. We need to stop time.

The Pause

“Stopping time” is a lovely turn of phrase that I can attribute to Scott Ellison who was quoted on the Marginal Revolution blog with this proposal:6

I propose temporarily stopping time. This means that today’s date, Tuesday, March 17th, 2020, will remain the current date until further notice. This also means that everything that happens in time (e.g. mortgage due dates, payrolls, travel bookings, stock market trading, contractor gigs, concerts, sporting events) will be paused. It also means that all of these events remain on the books, and will continue as planned once time is resumed.

He notes that most do this every Fall when we all agree that time will be paused one hour and pretend that we deserved more sleep. The problem, however, is that much of the economy needs to actually keep running — some more intensively than before — which means that just calling a time-out won’t do the trick.

The principle though is a useful one. Without something different, a business that finds themselves in trouble will have to shut down. Shutdowns are costly precisely because it is hard to get started again. Our hypothetical restaurant owner would have to find a new place, secure new capital, make new investments all before hiring people and opening up. It is like hitting the eject button and removing the CD from the player. Instead (and you can anticipate a tortured metaphor here), what the restaurant owner wants to do is hit the pause button. They want their business to stay where it is but stop playing.7

One obvious solution is for the private sector to be able to do this for themselves. Sure, our restaurant owner’s landlord could evict them because they are no longer able to pay rent. But the landlord could also not do that. They could realize — because it is plainly obvious — that the restaurant is a viable business in the middle of a hiccup and so agree to suspend rent payments. In actuality, they may not be technically losing out from this choice because (a) they are unlikely to find any other renter in the meantime and (b) they won’t have to look for another renter beyond that.

This is all well and good if the landlord has the power to make such decisions. However, behind many landlords are banks that have provided them with mortgages. They have provided loans to many property owners and may struggle to work out who is really participating in the pause. Thus, they may choose to foreclose on the landlords. If we could all see what was going on, maybe we could coordinate the pause without help. However, because that is risky and the pause button needs to be hit urgently, and governments can help coordinate that just like they do with daylight savings time.

This is not specific to rent or mortgage payments by small businesses. The services that comprise their fixed costs extend well beyond that. The popular fresh fast food chain in Boston, Clover Food Labs, put out a plea in March 2020 for tech companies to not require payments for three months.8 It’s founder, Ayr Muir, wrote:

I’m hours and hours into painstakingly reaching out to the HUGE number of services Clover uses to operate. For all it’s the same thing. (1) We want to use these services as soon as we re-open, (2) we DON’T want to lose all our data and set-up all over again, (3) We CAN’T pay while we have no revenues coming in.

Some companies responded to Ayr’s plea, but the majority did not. For companies that have otherwise very high margins, a pause would be a sensible response compared with pushing businesses off their services and making them pay the costs — in time and otherwise — of setting up again. The difference between these Big Tech companies and landlords is that it is highly likely they won’t face any costs from offering a pause.

All of these considerations apply beyond small business. There are employees who face consequences in terms of paying on-going household expenses should they find themselves unemployed. So, while we cannot necessarily expect them to be paid while not working for an extended period of time, the pause notion surely equally applies to them with respect to their rent, mortgages, debt and utility payments.9

How to Pause

For once, it didn’t take governments long to realize the nature of the problem. Through March 2020 they ordered lenders and landlords to hit the pause button on foreclosures and evictions for a month or two.10 French President, Emmanuel Macron was more strident and suspended utility payments and rent for small businesses promising that “no business would be allowed to fail.”11 The US government pushed back its annual tax payment deadline from April 15 to July 15 and allowed student loan payments to be stopped without penalty. But perhaps no country opted to “freeze” their economy quicker than Denmark. In mid-March 2020, they opted to pay 75 percent of all salaries of potentially laid off workers (earning up to $52,000 a year), guarantee 70 percent of new bank loans to companies and cover the fixed expenses of small businesses. The total cost was 13 percent of their usual GDP.12 If the US did the same thing that would be $2.5 trillion.

Halting consequences and payments was a very direct way of pausing the economy and making sure that the temporary harm is not baked in to the recovery. In other cases, the government tried to provide money to achieve the same thing. In Canada and the United Kingdom this included wage subsidies when businesses keep employees and delayed tax payments that businesses make on their behalf.

Perhaps the most radical proposal came from French economists, Emmanuel Saez and Gabrielle Zucman who argued that governments should become ‘payers of the last resort.’13 If a business was facing shutdown, the government would come in and pay for employees and for fixed cost payments such as rent, utilities and interest. In other words, they would have governments pay for businesses to pause. They suggested that unemployment payments could simply be made as if workers have lost their jobs to provide an easy route to such payments. They would also allow self-employed or gig economy workers to report themselves as idle to be eligible for such payments. For businesses, if they are part of lockdowns for more extreme social distancing, they would report their costs, be reimbursed and then any misreporting would be worked out later.

Is it better to stop bill payments or to pay them? Stopping certain bill payments is straightforward and easy to enforce. The problem, of course, is that it is not clear we are allocating the burden of preventing a recession equitably. In fact, when the dust settles, that won’t be the case. The problem is that, at the moment the policy needs to be introduced, there is no easy way of knowing this. This suggests that there may be some political fallout or economic recompense to be hashed out post-crisis. That uncertainty may actually cause some short-term problems to become long-term ones.

By contrast, paying bills can circumvent this by, in principle, sharing the burden at the outset. For instance, you could make sure that the hit to workers in terms of lost income was proportionate to the likely loss in capital returns. This is done by paying part of the invoiced amount of bills and wages. The challenge with this is that it requires some verification (eventually) of what those bills might have been and, in the meantime, a process of getting those payments to where they are needed. In other words, neither of these options is clean-up free.14

An alternative: income contingent loans

The problem with both stopping bill payments or paying them is that each becomes more difficult the longer the initial pandemic recession lasts. What is more, we do not actually have a good sense of how much more difficult these would become. In other words, they are really temporary emergency measures.

A measure that has the potential to last longer are government or private loans with a government guarantee. At the time of writing, various government support loans were being contemplated. As Sendhil Mullainathan wrote:

During the 2008 crisis, the government understood this principle well. It bailed out large financial firms for much the same reason: They were facing temporary shocks that, without intervention, would unnecessarily become permanent ones. Whatever else one may feel about those bailouts, that economic logic was sound. Those investments yielded healthy profits for the government.15

The same logic of using loans was also being given to some of the more hard-hit industries including airlines and hotel operators. Loans are a way of allowing bills to be paid without having to sort out what bills and how much because whoever takes out a loan is still responsible for repayments.

However, it may also be the case that, given the absence of revenue or wages, that full loans may be not be financially possible. In this regard, there is a debate regarding whether governments should step in and handle some of the short-term payments to give debtors financial breathing space or try and provide support to reduce the loan principal. The rationale for the latter is that it reduces the future debt overhang of businesses and others assisting them in getting back on their feet.

A careful study by Peter Ganong and Pascal Noel showed that if your goal is to prevent temporary issues becoming long-term ones, it is better to provide short-term help.16 Using the differential impact of certain programs offered during the financial crisis of 2008-09, they were able to measure the impact of reducing long-term obligations (a direct improvement to wealth) versus reducing short-term payments (assisting liquidity). As it turned out, the former did nothing for borrowers who were already under water while the latter significantly reduced default rates. This study strongly suggests that we want to help borrowers with government backed assistance for loan repayments rather than assistance paid directly to lenders to reduce loan principals.

Of course, providing this assistance to people directly can make it hard to tailor it to individual circumstances as well as being able to ensure that the repayment of any assistance is not onerous. As it turns out, however, an innovative Australian debt scheme used for higher education tuition could be readily applied. Australian universities are (mostly) public but still charge tuition to students. The rationale for that is that while education has public benefits, when you have an education you are the main financial beneficiary and so should be responsible for some of the costs. Thus, in the 1990s, the left-wing Labor government ended two decades of free tuition and put in its place an income-contingent loan.

The idea was this. You want to ensure that student loans are automatic and not onerous to administer. Thus, when tuition was charged, students could opt not to pay it immediately but, instead, incur a debt to the government. However, what you did not want is the repayment of those loans to depend too much on career paths. After all, a lawyer or doctor may be able to earn more than a high school teacher so you don’t want the latter to have debt repayments that presumed too high an income. The scheme instead gave students a slightly higher marginal tax rate until their loan principal (plus modest interest) was repaid. Thus, the high-income professionals would, by virtue of their higher income, be required to pay more sooner than those with lower income.

Higher education was a natural candidate for this type of loan but in 2004, my economist colleague Stephen King and I proposed a similar arrangement for housing.17 We suggested that when there were temporary shocks to someone’s income as might arise should they lose employment, then rather than evicting or foreclosing on them (as would be their initial worry), the government would step in and cover those housing related payments for a time. A debt would accrue but, like for students, it would only be repaid through the tax system, when people had income again. This would both provide stability for households when there were economic shocks but also, by providing financial breathing space, make lending or offering housing to people who might be more exposed to such shocks a better proposition for lenders and landlords.

There is little reason that such a scheme could not be enacted to cover short-term expenses associated with a pandemic recession. Presumably, only those who believed that they could pause their economic activity would avail themselves of this loan but then they could spread the burden over time. It would provide liquidity but at the same time ensure that those who received payments were responsible for them somewhat in proportion to their benefits.

The Final Stimulus

In many respects, the previous discussion is a somewhat optimistic one. It assumes governments get their acts together, can implement policies that pause the economy and that actually works. Since it has never been done before, economists have no idea whether it will be enough. Conceptually, it is a strong proposal. In reality, as with all of these things, there are consequences we cannot predict.

Bound up in the US approach to macroeconomic support in the US was a program to send checks of $1,200 to every citizen as restrictions were put in place. This was done after 9-11 and also during the 2008 financial crisis. The idea was to restore consumer confidence and spending. With COVID-19 or any pandemic, as the recession is not normal, one must wonder if such direct stimulus is appropriate. The worry is that, while this cash may support those people who have loan and other immediate obligations, with social distancing policies in place, these may not be consumed but instead saved. Saving can be beneficial if there is a need for liquidity but, in this case, that was already being provided by aggressive actions from central banks.

When a direct stimulus is likely to be required is part of the effort to re-start the economy as social distancing is no longer required. Thus, we might be concerned that directing policy towards a stimulus prematurely might hamper that option arising later and might detract from the decidedly not-normal task of pausing the economy at the outset of the crisis.

Daniel Babalola:

Typo: what makes this a recession

Daniel Babalola:

If you reference data from someone else, you should probably cite your sources. It improves credibility and allows others to look into that research.

Gray Newman:

Needs editing for clarity.

Michael Jones:

While the moral hazard of this strategy is not as strong as during the 2008-2009 crisis, by not relying on the private sector, the private sector now has the incentive to not keep adequate savings to absorb losses from pauses in the economy.

In the banking sector, the gov’t increased the capital requirements for banks, but would we really want the government to enforce adequate savings for private businesses? But if we don’t do this, businesses will take on increased risk and the economic costs of the next pandemic will be even higher.

Not that I completely agree with this - but it’s a provocative statement on at least part of the economy

"When a company fails, it does not fire their employees, it goes through a packaged bankruptcy," said Palihapitiya. "If anything what happens is the people who have the pensions inside the companies, the employees of these companies, end up owning more of the company. The people that get wiped out are the speculators that own the unsecured tranches of debt or the folks that own the equity. And by the way, those are the rules of the game. That's right. These are the people that purport to be the most sophisticated investors in the world. They deserve to get wiped out."

Michael Jones:

This analogy can be taken further if activity were measured on an hourly basis. Almost all of our economy shuts down every night.

Eric Rasmusen:

You might discuss bankruptcy law here. If there is just one creditor—the landlord, say—- he will hold off on rent because he knows he will get more if he waits and the business is viable, rather than forcing it to shut down now. The landlord’s bank will be patient too. But the Clover case is different. When there are multiple creditors, each one wants to get his money out first, even if he realizes that if they all waited a bit, they’d all get more. It’s like a bank run. The law of bankruptcy freezes debt payments and allows the creditors (with the court as backup arbitrator) time to coordinate.

Dermot Crean:

It’s not clear whether UK and Australian wage subsidy response was implemented in time to keep employees linked to employers. Australia’s package has yet to be deployed (11 April) - most payments will not flow until May due to lack of cashflow.

Dermot Crean:

Stopping bill payments - mostly what we are seeing is deferral so businesses will have substantial debts at the end of this shutdown. Many may not be able to repay.

+ 2 more...
Dermot Crean:

Many would disagree. The virus is the pin that burst a credit and growth bubble.

Many investors were raising concerns about stretched valuations, lack of earnings growth ex buy-backs, compressed credit spreads.

Howard Marks summarised it well in June 2019:

Small selection of others:

“Share valuations have not been this expensive since the tech wreck. Earnings growth is pretty close to zero. A supply shock is accruing in China. So is a demand shock. There are significant tail risks in corporate debt markets. And I haven’t even got to the threat of a global pandemic.” January 2020, Nucleus Wealth

At the moment, we feel strongly that global central banks’ decisions to hold nominal interest rates below nominal GDP at this point in the cycle means that almost all investors should overweight collateral-backed assets with upfront cash flow.” KKR, January 2020


“In today’s Chart of The Day I’m showing you a slide (76 in our Q2 Macro deck) I’ve been chatting with clients about for the last week:

A) PRE VIRUS, profitability was already deteriorating (like it always does at this stage of The Cycle)
B) Alongside Global #Quad4 Slowing since the beginning of 2018, US Labor Costs Rising was classic late cycle

That’s why:

C) PRE VIRUS, 37% of the companies in the Russell 2000 had NEGATIVE pre-tax income … and
D) PRE VIRUS, 27% of companies with market caps > $10B had NEGATIVE year-over-year EPS growth

“No one” (ex the legally blind) could have seen The Cycle coming, eh?

Small selection.