The only way to protect the economy is to defeat the virus
The stock market plunge on Monday has focused attention on the potential economic fallout from COVID-19 and the government's role in mitigating it. With interest rates plunging toward the zero bound, the Federal Reserve has little traditional ammunition left to pump money into the economy. President Trump is proposing a package of payroll tax cuts and small-business loans; liberal think tanks have urged greater direct support for low-income workers and state governments likely to face fiscal stress, among other measures. Other commentators are focused on the likely impact on the financial system of a sharp contraction.
Anything the government can do to mitigate the economic hardship faced by individuals is worth pursuing, and we should indeed be vigilant about preventing a literal virus from leading to financial contagion. But it's important to realize there is very little the government can do to prevent a contraction due to the pandemic. Moreover, the things we need to do to prevent the worst harm are precisely the things that will precipitate the contraction. If we continue to slow-walk those responses out of fear of economic damage, we'll not only cause more deaths and more stress to our health-care system in the long run, but substantially greater economic damage as well.
COVID-19 is a "real" shock, not a financial shock, and that difference has important consequences for how we think about the economic damage. A financial shock, such as the crisis caused by the bursting of the housing bubble in 2007, is ultimately a matter of accounting. Individuals and institutions that borrowed against assets suddenly discover that those assets aren't worth what they thought and will not generate the income that they thought. They face the prospect of insolvency, and fear of insolvency causes spending and investment to dry up, causing an economic contraction.
There is a great deal of debate about the best way to respond to financial shocks like these, but those revolve around which macroeconomic policies to deploy, rather than whether macroeconomic policy can be effective at all. The goal is to facilitate the economy redirecting resources to more productive uses, and mitigating the social costs of the transition.
The current situation is quite different. Factories in Wuhan weren't shut because there was no consumer demand for their products; they were shut because it was unsafe to run them. Tourism in Italy hasn't come to a halt because no one can afford to travel; it has come to a halt because no one is allowed to travel. COVID-19 is introducing massive friction into the economy, and that friction can't readily be alleviated by the manipulation of the money supply or the tax code. Resources cannot be redirected to more productive uses because they're being idled by fiat. If people can't go out, they can't earn, and they can't spend. And that means the economy will contract.
The compounding effects of the contraction are also substantially driven by how well the virus itself is handled. Business expectations of a sharp slowdown, and the massive uncertainty about its scope, is a big part of what is freezing up the markets. Will the United States look like Italy in a month, with all non-essential travel banned? The very possibility is surely already a factor being considered in corporate boardrooms, and affecting plans for cutting spending and laying off workers.
So the most important thing the government can do to reduce that uncertainty, and therefore the most important thing it can do to protect the economy as well, is to combat the virus directly. That means taking the kinds of measures, when necessary, that will cause more economic pain in the short term. If Washington state needs to impose draconian measures, they need to impose them sooner than later, both because that will better mitigate the impact of the virus on the health system and because it will allow businesses to start projecting when those measures will end rather than when they will begin, planning for recovery rather than bracing for disaster.
It also potentially means marshaling real resources directly to produce the most essential goods. New York state's decision to manufacture hand sanitizer directly in order to combat hoarding and price-gouging is a good example of the kind of thing governments might need to do in more areas. The fact that New York is using prison labor has drawn criticism, but that is exactly what governments do in emergencies: commandeer resources. The focus is not on social justice or on economic efficiency, as the left or right might respectively prefer, but on operational efficiency: getting the job done as quickly as possible. Any analogous efforts to ensure the supply of pharmaceuticals and medical supplies, many currently sourced from China, would likely do more to bolster public confidence than any economic policy measure could.
Obviously, the Trump administration is not the ideal team to lead in such circumstances. But in America's federal system, the states may be more important players than anyone in Washington. So even if all Rick Santelli cares about is the economy, it might be helpful if someone explained to him, and his audience, that our economic fate is now in Jay Inslee's, Gavin Newsom's, and Andrew Cuomo's hands.
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