The Economic Wallop of COVID-19: Q&A with RAND Experts


Mar 26, 2020

U.S. Senate Majority Leader Mitch McConnell and U.S. Senate Minority Leader Chuck Schumer meet with Treasury Secretary Steve Mnuchin to wrap up work on coronavirus economic aid legislation, Washington, D.C., March 20, 2020, photo by Mary F. Calvert/Reuters

Senate Majority Leader Mitch McConnell (left) and Minority Leader Chuck Schumer (right) meet with Treasury Secretary Steve Mnuchin about coronavirus economic aid legislation, Washington, D.C., March 20, 2020

Photo by Mary F. Calvert/Reuters

The speed with which large swaths of the U.S. economy have shut down this month—which some economists have dubbed “The Great Cessation”— is unprecedented. With Congress finalizing an economic stabilization plan to help distressed companies and send cash payments to some Americans, we asked several RAND researchers to discuss the outlook for the economy and strategies for relief and recovery when the COVID-19 crisis ends.

  • Debra Knopman is a principal researcher who previously served as vice president and director of RAND Infrastructure, Safety, and Environment.
  • Krishna B. Kumar holds RAND's Distinguished Chair in International Economic Policy and previously directed RAND's Labor and Population research unit.
  • Howard J. Shatz is a senior economist who specializes in international economics and development.
  • Jennifer Kavanagh is a senior political scientist who leads RAND's Countering Truth Decay initiative

They spoke on a conference call with RAND media relations director Jeffrey Hiday on March 23. What follows is an edited transcript of the conversation.

The economic hit clearly is going to be massive. Some bank analysts are predicting a 12 percent drop in GDP in the second quarter, some even more. What's the government going to do about it?

Debra Knopman: What's on the table in the Capitol is a $1.8 trillion package of measures to provide immediate relief to individuals through direct cash checks, $350 billion in loans to small businesses to cover their business interruption expenses, $500 billion to provide relief to other businesses through primarily loan guarantees, and a number of other measures.

This is just to provide an immediate injection of cash liquidity to individuals and small businesses. Right now there is something of a deadlock within the Senate as to how to proceed, and there are real differences of opinion with regard to how that $500 billion would be divvied up among businesses.

Could you talk a bit about the different buckets and what the intended targets are, maybe some of the possible effects?

Knopman: One of the several immediate needs is to get money to individuals using multiple avenues. In this particular bill, Congress is proposing to give at least $1,000 or $1,200 per adult, $500 for children, for all those adults who have filed tax returns. But there are many people who have not filed taxes; they will not be provided for in that particular mechanism. There are other social safety net programs—Social Security or food stamps and the like—where aid will need to be provided. There are several proposals out there to deal with small businesses largely through loans from the Small Business Administration. The point of this program—and the $500 billion for larger businesses—is to open the spigot on federal support to enable them to keep workers employed through the crisis. This is different than the “economic stimulus” we saw in the 2008 financial crisis.

You mentioned $1.8 trillion. How much can, or should, the country afford?

Krishna Kumar: To put $2 trillion in perspective, the United States is a $21.4 trillion economy, so we're talking about 10 percent. Interestingly, if you look at the drop that people are projecting, that is at least 10 percent of the economy. So given the drop in GDP that people are projecting, this does not seem an unusually large number.

One of the things people are worried about is that, going into the crisis, we were already running huge deficits and our debt was standing at around 100 percent of GDP. The question is, do we have leeway? But these are extraordinary times. They may call for extraordinary actions. At the end of World War II, our debt to GDP was 121 percent, and the United States clearly bounced back from that. So as long as the recovery does not take too long and the economy can get back on track, these numbers are not that large in the grander scheme of things. But eventually the United States will want to bring the debt-to-GDP ratio to a manageable level.

How can the money be allocated most effectively?

Howard Shatz: We can think about it two ways. One is what will get the economy moving more rapidly? Economic activity will create employment and that's one area of recovery. But that's the kind of thing to think about down the road. The immediate need is people who are going to lose their jobs, who don't have protections, and public health and health professionals.

Smaller businesses are likely to get hurt the most. They often have the thinnest profit margins and the fewest financing options.

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Howard J. Shatz

We want to give direct assistance to people who will have no other supports. Giving something to everyone may be the quickest way, but it's certainly not the most efficient, because there are many people out there who will not lose their jobs or sources of support. We could therefore more carefully target that kind of assistance. We also want to make sure that businesses that are at true risk will survive in some way. That might require assistance to businesses or financial institutions that would otherwise see all their loans go bad.

Smaller businesses are certainly likely to get hurt the most. They often have the thinnest profit margins and the fewest financing options. If major companies start cutting back, they might stop purchases from smaller suppliers or delay payments. In the United States, about 33 percent of all employees work for firms with fewer than 100 employees. In construction and such services as auto repair and personal care, this figure is above 60 percent. So if assistance to small business is limited, a lot of people will be affected. The best option may be to reach those employees directly if they lose their jobs. But more likely, both the businesses and the employees will need help.

Knopman: The other category of immediate need is money for emergency response and medical costs that are falling heavily on state and local governments—local governments in particular. They are on the front lines. Unlike the federal government, they're all required to balance their budgets and are operating under debt limitations in many cases. Some of these local and state governments have reserve funds—rainy-day funds—others do not. There is a push now in Congress to immediately inject money into state and local government budgets to make sure they've got the means to meet these emergency obligations.

Kumar: I want to mention unemployment insurance. If you look at the ways this disaster is unfolding, the phase one response was to address the immediate health impact. Phase two was paid sick leave and free testing. Now we're thinking about the next phase. People are getting laid off, so how do we get money to them?

The $2 trillion package does involve boosting state support for employment insurance. For example, states like California are already waiving the one-week-wait limit.

With respect to allocating resources, I completely agree that you have to be very careful because we have, in addition to government debt at 100 percent of GDP, we have corporate debt at $10 trillion, or about 47 percent of GDP. So while the intention to help companies is well-placed, we have to be careful. Howard was mentioning companies that have a good chance of surviving—in other words, those companies that would have done well were it not for the crisis. These should be at the top of the list for help.

Which ones should get more or less of this money? Is it right for companies like Apple to get a few billion?

Kumar: Clearly Apple has a huge amount of cash reserves. In fact, incentive compatibility, as economists would call it, demands that we not make the interest on these loans too low because you want companies with future prospects and returns and companies that lack cash reserves who were behaving responsibly fiscally to be able to get this money first.

For example, 16 percent of publicly traded U.S. companies are not even making enough money to pay interest on their debt. That's why you have to choose carefully.

Shatz: I think the other point is program design. You don't just want to give assistance to companies away for free, at least to larger companies. If it's a loan, they're going to have to pay back that loan. You would like a company like Apple to look at the terms of an assistance flow and say, “Well, those aren't very good terms. It's much better for us to use our cash.”

There has to be some skin in the game by the companies—whether it's a higher interest rate with a government loan or some kind of restriction while they have the assistance, such as whether they can buy back stock or how they treat employees or executive compensation. These are the kinds of terms you might want so that companies have to make a choice that it is worth their while, and the U.S. government would not be throwing away money where it's not needed.

Let's try to put this in perspective. How does this compare, for example, to the 2008 financial crisis?

Shatz: The most recent estimates from investment banks suggest that the second quarter will be the largest quarterly decline in the United States since World War II.

The decline in quarter four of 2008 was about 8.4 percent on an annualized basis. Estimates are putting the annualized decline in quarter two of this year at around 13 percent. So it's very large.

There's also been good work on what disasters do to economies. After World War I, World War II, and the Great Depression, the Great Influenza Epidemic of 1918–20—perhaps our most relevant comparison—is number four in terms of economic decline.

When we look at major historic events like this we see GDP and equity markets decline, while unemployment rises. But we also see very low, risk-free interest rates—government bonds, for example. There's some discussion about why that is the case. I think right now, as we saw in 2008, there's a big flight to quality or certainty, and the U.S. government, even at the debt levels mentioned earlier, still offers the best certainty for investors to get their capital back.

We have to be careful that we don't convert a health crisis into a financial crisis… It is extremely important to contain the health crisis first.

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Krishna B. Kumar

Kumar: One way I think the two cases differ is that the 2008 Great Recession was a financial crisis that spilled over into the real economy. Whereas this is a real health crisis that is spilling over into the economy and the financial sector. That is why we have to be careful that we don't convert a health crisis into a financial crisis.

From a policy point of view, that is why it is extremely important to contain the health crisis first, because if we don't, people are not going to go out, people are not going to spend. The hope then is that the recovery will be hopefully quicker than it was in the 2008 crisis.

How close are we to a recession or, worse, a depression?

Shatz: We are probably in recession right now. Depression? That's a tough call. There are huge differences between now and the 1930s. One is that we've learned from events. We have a pretty good government infrastructure now on how to handle these issues. In fact, in the Great Depression, the Federal Reserve did exactly the opposite of what it should have done.

So we've learned from the past. And, since the Great Financial Crisis of 2008, with new laws in place and with bureaucracy to handle this, the Federal Reserve and the Treasury are well prepared. That's why we saw, last week, different financing facilities get rolled out by the Fed. That's why we're seeing big rescue packages now. That's also why it looks like there's going to be a European package, too.

What are your thoughts on the recovery rates in the Asia Pacific, Europe, and the United States? Given the almost near recovery already of some first-hit countries—China, Japan, Korea—what might we realistically copy from these efforts?

Knopman: There is a close connection between getting the public health emergency under control and being able to restart the economic engine. There's a distinction to be made, however, between the restarting process, and the kind of fiscal and monetary policy you do for that, versus a stimulus when you're in a deep recession like in 2008 where you need to pump up demand. Of course, unemployment was much higher then than what we had at least a couple of weeks ago. So a lot is depending here on the timing of getting the public health crisis under control. That should shape the policy responses to re-starting or getting the economy back on its growth path.

Kumar: One interesting point here. During the Great Recession there was talk about whether there's a decoupling—whether the emerging economies and the developed countries are behaving differently, so that if one part of the world is not doing well, the other countries may still do well. It doesn't always happen.

But as we are seeing, China, Japan, and South Korea are going to recover earlier just because they faced the crisis first. So we could see the “decoupling” happen where they first start off and bear the burden, if you will, of reviving the global economy. Let's not forget that we are all hugely interconnected with global supply chains. We talked about Apple, which shut down many of its stores in China during the crisis, but now they're reopening. So for the globalized U.S. companies, this might offer some relief if some parts of the Asian economies pick up faster.

Some are wondering if the cure could potentially be worse than the disease. Is it too soon to think about an exit strategy to emerge from the shutdowns and isolation? Are we going to reach a point where we just have to get the country to go back to work?

Shatz: That certainly is a risk. I would refer to what Debra said: We have to take care of health first. If we trace the causes of the economic problems, they were a supply shock caused by a health crisis in China, and then demand shocks. We also have other supply shocks with Europe being closed.

Think about this: China is a major trading partner, and its shutdown negatively affected a lot of U.S. businesses. But the United States receives only 15 percent of its imports from China and sends only 7 percent of its exports to China. We send 34 percent of our exports to the EU and receive 30 percent of our imports from the EU. Now those economies are shut down. Our neighbors Canada and Mexico are also major trading partners with us, so our economic health will depend in part on theirs as well.

So if we don't solve the health problem, this could go through waves. In fact, the 1918 flu pandemic went through three waves. That would certainly be not something we want.

But it's not too early to start thinking of recovery. Public health authorities are, I hope, thinking: “How long do different communities have to remain in lockdown before we're reasonably sure that the virus will not spread anymore? Or spread too fast?” Part of that may hinge on the development of a vaccine.

We do want to release people from the lockdown at some time—but not too soon. That's not necessarily an economic issue. If the lockdown remains for a long time, that may just mean that more assistance would be needed. But keep in mind that many businesses are not shutting down, so not all economic activity is coming to a halt.

Knopman: This is where adaptive management applies to government. We're familiar with this in business dealings: As you get in new information, you make changes, you pivot in your business strategy.

The government is going to need to stay agile. Of course, many of these decisions are being made at the state and local level based on their own circumstances. So it's not a wholly coordinated response nationally at this point in time.

I would hope that those in the federal government are thinking about what those trigger points are, what those decision rules are going to look like for easing up the restrictions. It may be contingent on the availability of testing and the ability to segregate those who are infected and allowing those who are not and who don't pose a danger to others to be back out and about.

Kumar: About exit strategies—let's not forget that the Fed has been pumping the economy with much-needed liquidity. Because the financial plumbing system has been in danger of getting frozen and you want there to be a counterparty to buy the assets and so on, the Fed is doing that.

But even going into the crisis, the banks were sitting on $1.3 trillion of excess reserves. The cash was sitting in the banking system. So think of it as a dam where a lot of water is getting accumulated, and there is a crack. All this is going to enter the economy and cause inflation. So when we think of the exit strategy, we should be thinking about how the Fed is going to unwind quickly enough so that we don't face inflationary pressures.

Japan seems to have dealt with this crisis quite differently. What do you make of that?

Kumar: Well the Bank of Japan did end up with the security purchases as well, so it's not like they've done something drastically different than the Fed. But they might've been a little bit different on the stay-at-home and other policies.

One of the things that is becoming very clear is that the effect of this virus is highly heterogeneous across countries. What is happening in Italy is very different from Spain. Even within the United States you are seeing that what's happening in New York and Washington and California is extremely different.

All of us on this call are talking economics, but we keep coming back to the primary health crisis and the need to keep the number of cases under control. Once that happens, we might have more flexibility in our policy actions as well.

What about pumping billions—or hundreds of billions—of dollars into infrastructure as a way to guarantee employment or kickstart the economy?

Knopman: While we're still in this health crisis, pumping money into infrastructure is not going to help because we're trying to not have people in workplaces—whether the workplace is out on a highway or at a water treatment plant. But certainly, once we start to come out of the immediate health crisis, I think there's going to be huge need to help bolster the state and local budgets.

While we're still in this health crisis, pumping money into infrastructure is not going to help, because we're trying to not have people in workplaces.

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Debra Knopman

One way to do that is to have that funding focused on infrastructure operations and maintenance, which is not what the federal government typically does when it provides aid to state and local governments for infrastructure. That takes enormous pressure off those local budgets so money could be used on social services, public safety, and the like.

Over the longer term, the federal government could start pumping in more money into infrastructure for new projects. But you don't want to be throwing money around without careful thought. You want to make sure you can match up your excess labor to the extent you have unemployment in certain areas and can get that directed to the infrastructure needs in that region. So although I do think that is going to be a way to get the economy moving again, those jobs are temporary, and practically speaking this would have to be spread out over probably a 10-year period.

Obviously, transportation infrastructure is being used a lot less now. Here in Washington the trains are running at a much lower frequency, and I presume revenues are down sharply. What does that do?

Knopman: This is having a huge effect in major urban areas where they're trying to maintain public transit, whether it's New York's subway, New Jersey transit, BART, WMATA Metro here in Washington DC. Their revenue streams have collapsed. And yet as a public utility, they need to keep operating. So operating subsidies to these entities is extremely important. This is what is under discussion in the Senate now. Once people are able to get back to work, pumping money into these systems' backlogs of deferred maintenance will also help enable the recovery.

I suppose this could have other knock-on effects, such as municipal bonds not being as sturdy as they were.

Knopman: All sorts of things have been happening with the municipal bond market. Basically it fell apart. Today, with the Fed action, there seems to be some restoration of a semblance of a market.

But the problem is that because of this liquidity crunch, these bonds—which have an extremely low default rate at something like 0.01 percent over the last 40–50 years—are being sold off to purchase 10-year Treasuries or just cash. There's going to be a huge demand from state and local governments to borrow immediately to go back into this market. It's going to be tough for them to sell those bonds until there's a stabilization in these markets.

With the economic recovery so tied to health recovery, as we've mentioned a few times, aren't we in completely uncertain times?

Shatz: We are, and the uncertainty is driven by not fully understanding the nature of the disease. Once we learn more about it and how to deal with it, we'll have more certainty.

In terms of duration, that's also going to depend on what we learn about the disease. If the reports from China are correct, China basically shut down for two months. Parts of China are now, while not operating at 100 percent, back operating decently.

Provided the information coming out is correct, China is worth watching to see whether what they've done in fact has reduced the disease to low or manageable levels, and then to see how their economy has recovered. If they're operating partially after two months, and that continues on that trajectory, then perhaps we're looking at another two or even six months. And then if there's, unfortunately, a reemergence, sure, we could be looking at a year. But right now, given China's trajectory, it looks like four to six months—but with a very wide error band around that.

Knopman: I'd like to inject a note of optimism here. In the wake of the 2008 financial crisis, state and local government budgets were hit really hard and many didn't get their finances back in shape until the last couple of years.

But they learned a lot. And the vast majority of states now have rainy day funds. Same for most cities as well. There is more resilience in their financial management. So while they will have revenue shortfalls in the near term, we hope it's going to be short-lived.

They also are building on a somewhat more solid base and know what to expect in the coming years of having to adjust their revenue projections. If a state is dependent on income taxes, capital gains, they're going to see big, big hits. But overall, I believe there's more resilience in the system at that level than there was in 2008 and 2009.

Kumar: One thing adding to the uncertainty is that some of our health experts are saying the virus could recur in the fall. But if we can get even a few months respite, we can actually prepare for it. We can put in more protections in place for workers and consumers.

In fact, preparing some of the health care equipment and so on can be part of the recovery process if we can handle training and placement of workers. One of our colleagues looked at some of the past pandemics and was able to show that the economy in all cases, most recently the SARS epidemic, turned around and grew faster right after the crisis.

The stock markets clearly are not appreciating all the uncertainty. How is the level of uncertainty being affected by what RAND terms “Truth Decay,” the diminishing role that facts play in making important public policy decisions?

Jennifer Kavanagh: Truth Decay contributes in a number of ways. The first is through the myths and misinformation that exist about the virus—about its mortality rate, its trajectory, how quickly it spreads, how it spreads, whether you can spread it when you are asymptomatic.

But there is also disinformation and misinformation about government policy—whether you're talking about local and city government or Congress or the Fed. There are rumors about everything. When people don't know where to turn, they react to any information even if it is false.

Can you talk more about low trust public trust in institutions and how misinformation is part of that?

Kavanagh: Trust is very low in all of the institutions that we are looking to for information and for responses to this problem. Trust is low across all types of media platforms and all levels of government. It's higher for local government, higher for city government, but still really very low in the bigger picture.

So people don't know where to turn for good information, and they don't have any confidence that the government has this situation under control. My colleagues have mentioned several times that in order to stabilize the markets and have an economic recovery, we first have to control the public health crisis. Part of that is having the American public believe that the government is capable of dealing with this crisis.

Part of controlling this public health crisis is having the American public believe that the government is capable of dealing with it.

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Jennifer Kavanagh

Economically, what are going to be the long-lasting impacts from the virus?

Shatz: I think we're going to see a number of things that will sound very familiar to people who have been watching the trade war. For example, I think there's going to be a lot more emphasis on resiliency and diversity of supply chains.

There's going to be much more sensitization to risk. We may see more government consideration of what must be or what should be produced in the United States. Maybe more stockpiling of goods that we think would be important in the case of disaster or other crisis.

This would mean somewhat less efficiency in the economy. But maybe it's something like an insurance policy: For those who are lucky, it's just an expense. But for people who are unlucky, there's a big payoff.

Given that much of the needed medical supplies are imported, what about the recent trade tariffs?

Shatz: I won't go into whether the tariffs should be rescinded. I will say that there are no trade heroes so far from the pandemic. There have been several dozen new restraints added onto trade and medical supplies. I don't think any have come from the United States since January.

In addition, we're learning that many countries have a number of trade restraints on basic things. For example—and this is coming from the very good team in Switzerland at Global Trade Alert—there are a number of countries that have high barriers on soap. All of a sudden, we're learning that maybe you don't want high trade barriers on soap.

The discussion about tariffs on health equipment is going to go hand in hand with thinking about location of production of medical goods.

Kumar: At the same time, we're seeing a huge increase in scientific and medical cooperation across countries. So, counter-intuitively actually, I think this can bring the world together, and you're going to see more scientific and medical cooperation going forward.

Given the medical, health, and economic effects, if there was more widespread testing, would that enable people to get back to work more quickly?

Shatz: I will approach that from a data perspective. If we were to have more widespread testing, we would probably find we have a lot more cases. Then what we know about the disease would change dramatically.

We might find that the fatality rate is lower than we think. We might find it's more widespread. We'd be able to do more contact tracing. It might allow us to recover more quickly because we'd be better able to see where the disease is going.

You put those together, and more testing probably means better understanding of the disease, more targeted health intervention, and a more rapid recovery.

What are the three most important things a city and its business community can do now to speed economic recovery from COVID-19?

Kumar: The local response to the crisis has been nothing short of terrific. At the end of the day, the disease exists in communities. Right now, the key thing that cities and communities can do is to get information out there on safety and distancing, what kind of restaurants are open, and so on.

As soon as it is safe to go out, I think cities can help increase confidence in the safety of public places and restaurants. That might mean more testing, more cleaning of public places.

The second thing governments at all levels can do to help aid this recovery is to remove frictions. For instance, they can provide job matching services by listing openings. They can organize job fairs. They can speed up local permits for construction and other things.

Third, they can provide assistance to households and businesses to avail themselves of stimulus benefits out there.

Shatz: To make sure that local economies don't decline, I'd think about what steps can be taken to keep businesses going. Allowing or facilitating restaurants to do take out, for example, is very good.

The other thing is that municipalities, especially smaller towns, are going to have limited ability to finance recovery. If they do have reserves, a question could be, can they delay taxation? Can they delay fines? Can they delay things that will cause their residents to have to pay into the city rather than to pay for businesses?

Knopman: Forbearance is a word that I think we're going to hear a lot, and not just from the point of view of banks loosening terms with borrowers. Local governments may need to consider similar approaches with tax payments.

Zooming back out, what is the impact of the virus on international relations and the U.S. position in the world?

Kumar: RAND's very own Ambassador James Dobbins and I have an article that should be coming out saying that on the international front, closed should not become the new normal. This is not a time for us to make permanent the temporary barriers that we have erected out of necessity.

We quote an author who said that you cannot protest against globalization because nobody's in charge. Globalization is a result of 7–8 billion of the world's citizens wanting to be interconnected and be in the global supply chain.

I already mentioned the medical and other coordination that exists. So I think that we should try to cut down trade barriers, increase cooperation, be more a greater part of multilateral organizations.

Shatz: There is something of a PR effort right now in terms of major countries trying to establish themselves as the global leaders. I think it's much too soon to say whether this will actually have any effect.

What people who may be skeptical of the United States should keep in mind is that the United States moved very quickly to shore up its international partners in particular—as we did in 2008—on the financial side by the Fed extending swap lines first with major central banks and then with emerging market central banks. And the world, for better or worse, operates on dollars, and the United States moved very quickly to make sure that the world could continue to operate on dollars. So there is multilateral action going on at many levels.

I think it's much too early to say how the globe will reshape—especially because it depends on whether countries really have the capability to serve as international leaders too.