A different problem will arise if the pandemic scars economies, reducing tax revenue and increasing welfare spending for a long time. The result would be a persistent shortfall in the public finances. Yet the extent of the pandemic’s lasting impact is highly uncertain owing to the novel nature of the crisis. The main driver of recent economic fluctuations has been government diktats about whether shops and restaurants can stay open, the impact of which baffles orthodox economic models. America’s unemployment rate undershot the Fed’s summer forecast by more than two percentage points within a matter of months. The scenarios presented by Britain’s official forecasters this week ranged from there being no enduring damage to a long-term hit to GDP of 6% a year.
It is better to wait to see how large a hole the pandemic leaves in budgets than to risk slowing the recovery with premature austerity. Britain has chosen to wait. More countries should follow the example of Australia and pledge not to tighten fiscal policy actively until the economy has crossed a defined threshold—in its case an unemployment rate of 6%. Much as clear “forward guidance” by central banks helps monetary stimulus to work, fiscal rules would help boost confidence in the future.
Sadly, putting in place a new, formal, fiscal framework will be hard in America, with its divided and gridlocked political system. All the same, a pragmatic deal may be possible in the short run—Democrats should accept the smaller stimulus on offer from the Republicans, rather than hold out for the enormous spending they would prefer. With the unemployed burning through their savings and small firms facing a bleak winter, the speed of emergency support matters more than its size.
The consequences of any policy mistakes will be all the greater today because low interest rates mean that central banks cannot easily ride to the rescue. Governments can afford to wait a little longer before tightening the purse-strings. And waiting is the cautious and responsible choice. ■