In this weeks blog, NERI Co-director, Dr Tom McDonnell describes the economic fallout and the appropriate policy response to the Coronavirus economy.
Those early hopes from last March that we could put the economy into a 12-week deep freeze and then re-emerge with a quick v-shaped recovery were always too optimistic and now look hopelessly naive. The NERI's Latest Economic Report describes the economic fallout and the appropriate policy response. The reality is that fiscal and monetary policy will need to highly remain expansionary for some time to come.
The speed and scale of the labour market decline in the second quarter has no precedent in the last 100 years. Cross-country labour market comparisons are somewhat difficult. This is due to divergent policy responses and different classifications of labour market status. It is clear however that labour markets everywhere have been severely affected.
The US unemployment rate swiftly transitioned from full employment in March (3.5 per cent unemployment) to a peak unemployment rate of 14.7 per cent by May on account of almost 20 million jobs lost in April. Less than half of US job losses had been recovered by August. The ECB estimates that euro area employment fell 5.1 million between the final quarter of 2019 and the second quarter of 2020 – a 0.3 per cent decline in the first quarter and further 2.9 per cent decline in the second quarter.
The smaller decline in euro area employment relative to the decline in economic activity is largely attributable to the use of job retention and related schemes aimed at preventing redundancies and at supporting the self-employed. In Ireland’s case these policies manifested as the Temporary Wage Subsidy Scheme (TWSS) and the Pandemic Unemployment Payment (PUP) respectively. As a result, average hours worked declined much faster in the euro area (3.8 per cent in quarter one and then a further 10.2 per cent in quarter two) than did total employment.
Similarly, hours worked in the UK declined over 18 per cent between the first and second quarters despite the official unemployment rate remaining below 4 per cent.
The ECB notes that survey-based data is indicative of further job losses in the third quarter. A second surge in the pandemic over the Autumn/Winter period, as seems likely, would lead to further job losses and potentially to a cascade of business failures.
The Republic of Ireland’s economy was undergoing a robust cyclical upswing prior to the onset of the pandemic. Annual employment growth averaged over 3 per cent between 2013 and 2019 while annual growth in modified domestic demand averaged over 4 per cent between 2014 and 2019. By the end of 2019 the labour market was approaching full employment with an unemployment rate below 5 per cent. Average nominal wage growth (hourly and weekly) was in excess of 3 per cent and wage growth was in excess of 2.5 per cent in real terms.
Although labour market conditions were still improving on the eve of lockdown, the domestic Irish economy’s long cyclical upswing appeared to be somewhat slowing down. The onset of the pandemic in March along with the ensuing policy response generated the greatest shock to the Irish economy and labour market in the history of the State.
Swift and decisive emergency policy responses from governments and central banks prevented even larger declines in output and employment. Crucially, there should be no cliff-edge removal of these supports. Central banks will need to make ‘whatever it takes’ commitments to ensure that governments are able to continue to act as income and liquidity sources of last resort well into 2021. In particular, central banks should continue to underpin support for government borrowing by guaranteeing that policy rates will be kept low out to the medium-term and maintaining asset purchases.
Governments in turn will need to maintain fiscal supports until well into 2021 and beyond and remain ready to reintroduce emergency income and business supports if and when incidence of the virus requires further lockdowns on economic activity. Governments should also delay budgetary tightening measures such as tax increases and the roll back of income supports and stimulus until at least 2022 and at minimum until a vaccine is widely available and deployed.
A final point is that the Covid-19 crisis may compound the medium-term decline in productivity growth that took hold in advanced economies in the 1990s and that accelerated in the aftermath of the financial crash. Sectors involving social interaction will experience increased costs per unit output in at least the short-term. Prolonged higher levels of unemployment will likely lead to some degree of skills erosion. The higher levels of uncertainty will depress levels of business investment. At the same time, ageing demographics will put increasing downward pressure on hours worked leaving productivity gains as the remaining lever for economic growth.
Governments should therefore focus their stimulus packages on reversing the persistently low levels of investment in the productive capital stock. Investments in infrastructure can be targeted to support the necessary transition to a zero carbon economy while increased investments in education, retraining, public R&D, public childcare supports and child poverty reduction can all help improve labour productivity over the long-run.