“All-Runner” Set

Zero rates, cash giveaways and tax cuts: how to save the economy from collapse

The global economy is under incredible pressure. The coronavirus has drastically reduced demand and production in many countries, and they are unlikely to recover quickly. Uncertainty looks to be the highest since at least the 1980s.

We can assume that decisive action by central banks to reduce rates and governments on budget spending and taxes is unlikely to lead to a quick recovery in business activity. It will be especially difficult for Russia because of the dynamics of commodity markets and pressure from the United States.

What can central banks and governments do in this situation, and why is their arsenal rather limited, and the ability to influence the economy doubtful? In addition, why did they begin to act in concert, although they are formally independent?

Special monetary path

The world has found itself in a series of coincident crisis phenomena that threaten to radically worsen the economic condition of all countries this year. The coronavirus and the subsequent self-isolation of Asian and European citizens automatically puts pressure on supply and demand (because production chains are broken), significantly reducing business activity.

In such a situation, the fall in the cost of commodities was quite expected, and this shifts the balance in the Russian economy, reducing possible growth. And financial markets have sunk so badly that the S&P 500 is almost back to where it started in early 2017 under Trump, and many other markets have collapsed as well.

Uncertainty is incredible: JP Morgan's March 18 global and China growth forecasts were too big to believe in such a 41% drop in the first quarter of 2020 and a 57% increase in the second quarter, and similar estimates for the Eurozone of 45% growth in the third quarter of 2020.

At the same time, the indicator of world economic uncertainty rose to almost historical highs; it shows how difficult it is for a business to make an investment decision in the current environment.

The situation in Russia is very different from the global one. On March 20, 2020, the Bank of Russia decided to keep the key rate at 6%. This is one of the highest rates in the world, and even higher than expected inflation (about 3.5-5% at the end of 2020). Moreover, unlike other countries, we have an extremely low public debt to GDP ratio, less than 15‒16%. The EU average is about 82%, in the US it is over 100%, and in Japan it is 238%. Yes, and international reserves, in Russia they are already more than the total external debt of the state and companies.

Therefore, there is room in Russia for lowering rates and for additional government spending. The Bank of Russia has already announced that it will help the development of mortgages, SMEs and the well-being of citizens; and the government has published a set of measures to be applied to stabilize financial markets, businesses and regional budgets. Most likely, they will have to be increased in volume, but the steps are absolutely adequate and timely.

Why can't we make the rates zero? For about the same reason as in other BRICS countries, this will put a lot of pressure on the foreign exchange market, since foreign investors will not be able to earn at high rates and will sell bonds with the exchange of rubles for dollars. In addition, the Central Bank is very concerned about inflationary risks that may affect the well-being of citizens. Therefore, zero rates are currently unavailable for all these countries.

Central banks are no longer the same

As has been the custom since 2009, governments and the Central Bank do not have many options. Historically, central banks have raised rates significantly after recessions, and they have had room to maneuver before the next crisis. On average, this represented an increase of 4% and then the possibility of similar declines.

But the crisis of 2007-2009 finally deprived the Central Banks of developed countries, including the United States, of the opportunity to quickly raise rates. The first rate hike by the Fed came only at the end of 2015, six years after the recession, and then the rate peaked below 2.5%. This turned out to be too little growth, and in March 2020 it was again reduced by as much as 1.5% to virtual zero.

So new measures were needed; however, most of these measures, including the purchase of government bonds and corporate bonds on the Fed's balance sheet ("quantitative easing"), were already used in one form or another during the crisis of 2007-2009. These measures do not bring anything new to the market, and, as a result, they will not have a big impact on rates and business activity.

There are studies showing that in the past, quantitative easing worked only in 2008-2009, and after that it only supported demand, but did not affect the economy. Most of the major Central Banks have already found themselves in the zone of zero interest rates - except for the BRICS (Brazil, Russia, India, China, South Africa), Turkey and Mexico.

Almost the last measure not yet used by the Central Bank is "helicopter money", that is, the distribution of funds to citizens directly.

At the same time, the question constantly arises, due to what this will happen, since any Central Bank has a natural balance of assets and liabilities, and it cannot simply “print money”. Except perhaps by reducing equity capital, which will create some financial stability risks. The government has the opportunity to take similar steps, which are discussed below.

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Governments have more options. In principle, fiscal (budgetary) measures can be very effective if applied at the beginning of crises and with the most targeted approach. For example, in almost all countries, investment, spending on infrastructure, and often education are “positive multiplier” measures, that is, they increase business activity. Many countries, including Russia, have already begun to either cancel or defer corporate tax payments, reduce lending rates - especially for small and medium-sized businesses, and support the most affected sectors of the economy, including HoReCa (hotels, restaurants and cafes).

Some countries are already implementing a refund to the public - technically a tax measure in which the Treasury sends a check to every affected citizen, and this check comes from reducing their taxes or from new loans that the state makes.

In the United States, these returns could be in the trillions of dollars - against the backdrop of a GDP of $21 trillion, these are very large sums.

Unfortunately, in the current crisis, these measures may still be insufficient. Firstly, the impact on the supply (that is, on the production chains) technically leads to less availability of goods and services - except that this cannot be said about online, and even there it has already come to the point that YouTube and Netflix can reduce the quality of their videos in order to do not overload networks. Again, the infrastructure built by mobile operators is not completely enough.

Secondly, the issue of returning funds to citizens looks very good from a distance, but upon closer examination, it may not work to maintain demand. If people pay off old debts instead of buying, the money may not reach the business, and therefore government spending often works somewhat better during a crisis. This has been shown in several past experiments in both developed and developing countries.

The low and near-zero rates of most central banks are the result of their quick response to the huge macroeconomic risks associated with the coronavirus and quarantines.

Most likely, neither these measures, nor government measures to support business, will be able to have a guaranteed positive impact on the economy. Unfortunately, we have fallen into a zone of extreme uncertainty, and now it is very difficult to imagine what awaits us in the coming year. In Russia, rates are still left non-zero, as, indeed, in other emerging markets similar to us.