How policymakers can ensure the best post-COVID-19 recovery possible

“A crisis of this magnitude is an opportunity to improve the structural underpinnings of our global economy, and infrastructure spending would definitely help.” Jérôme Jean Haegeli, group chief economist at Swiss Re.

· "Unusual dynamics" of recession expected to drive "paradigm shift"
· Concerns over impact of $12 trillion of global negative yielding debt
· Central bank purchases ​​are huge but have "not peaked yet"
· Call to enhance policy stimulus to improve economic trend growth

Too little attention is being paid to the important role of policy stimulus in any post-COVID-19 recovery, yet it could set the scene for the strongest recovery possible, argues a top economist.

Recessions happen. Many of us will have lived through them many times before the global COVID-19 pandemic ushered in the worst recession of our lifetime.

“This year’s recession could be one of the deepest and shortest on record. Yet, we shouldn’t underestimate the longer-term economic and political implications,” says Jérôme Jean Haegeli, group chief economist at Swiss Re, as he set out his rationale for how to achieve economic resilience post-COVID-19 at a Swiss Re virtual roundtable on June 2, 2020.

He expects to see a sharp economic contraction this year, with a partial recovery in the second half of 2020, followed by a strong rebound in 2021.

The global economy is expected to contract by minus 3.9 percent with lost economic output of $12 trillion that will not be fully recouped.

The impact of this recession will be “much worse than the global financial crisis of 2008”, which inflicted a minus 1.8 percent economic contraction. He says that rising unemployment and bankruptcies will be inevitable, while interest rates will remain very low as financial repression rises, and risks will be tilted to the downside.

On a more optimistic note, he adds that there will probably be a recovery quite soon.

“We are already seeing something in the economic data, but this recovery will be protracted,” he explains.

More economic resilience is needed

“We’re always going to have recessions and we’re always going to have recoveries,” Haegeli says stoically.

“We should also spend more time thinking about the environment, the institutional framework and what the insurance sector and policymakers can do to make sure that when we have these natural recessions—we should have them and it’s not a bad thing—we can absorb them and grow out strongly.”

Given the enormity of the fallout and the need to enable the best possible recovery, Haegeli has been thinking hard. He argues that there has not been enough emphasis on the potential of policy stimulus to support a better post-crisis recovery.

To get a handle on where and how policymakers can make the greatest difference, Haegeli highlights key influencing factors.

For him, global economic resilience, or the relative lack of it, is an overarching issue: it’s a key factor in how well the global economy copes with shocks.

“We definitely need more resilience in a protracted recovery,” he says.

“On the resilience front, the global economy is not performing well, and even before the COVID-19-led economic recession it had not performed well.”

Haegeli references Swiss Re’s Sigma report “Indexing resilience: a primer for insurance markets and economies”, published September 7, 2019, which used new macro indices to track the structural ability of an economy to absorb shocks.

It shows that global economic resilience was already depleted in 2019 relative to 2007/08, before COVID-19 struck. Haegeli says:

“For me that is a key indication that the recovery will be more protracted.”

Other factors such as the huge increase in negative yielding debt and the amount of public debt hangover will also impact the recovery.

Prior to the 2008/09 global financial crisis, the amount of negative yielding debt globally was “literally zero”, Haegeli says.

“It now stands at $12 trillion, which makes the current debt a relatively new development,” he explains—another key indicator that the global economy was already less resilient before COVID-19.

On top of this, the world is entering the 2020 recession with a public debt hangover.

“If we look at the G7 countries’ public debt, it increased from a 130 percent debt: GDP ratio 50 years ago to 270 percent as of 2019.

At the end of 2020 it will top the 300 percent mark. This is definitely an unprecedented time,” he says.

What really concerns Haegeli, he adds, is that despite the massive amount of negative yielding debt pre-COVID-19, which indicates huge amounts of central bank purchases and fiscal stimulus, there has been no increase in the economic trend growth. Comparing figures for 2019 with 2008 reveals that global economic trend growth now is about 2 percentage points lower than in 2008, which he finds “remarkable”.

New normal

As this recession has such “unusual dynamics”, it is perhaps no surprise that Haegeli predicts the world is in for a “paradigm shift” that will have long-lasting effects.

The COVID-19 pandemic is not the only thing driving major changes. He acknowledges the influence of the subdued recovery from the 2008/09 global financial crisis which, together with the US–China trade war, and now COVID-19, is accentuating some of the economic trends already happening. Examples of these are greater levels of government interventions, that globalisation and parallel supply chains may have peaked, and accelerated digital transformation.

However, the loss of global output as a result of the pandemic shutdowns will be of a magnitude not seen in our lifetime, potentially bringing a new normal that will mean hardship for many.

Global economy capacity use is down 20 percent in the most important economies, and in China it is down 7 to 8 percent, he says.

As lockdowns begin to ease, the impact will become clearer.

“You cannot unfreeze the global economy as if nothing had happened. The global economy won’t go back from 80 or 70 percent of capacity use to 100 percent capacity use. Even if all social distancing measures were relaxed we will not get 100 percent. We expect at most the economic capacity will be at 95 percent,” he explains.

If pre-COVID-19 trend growth is compared with the current COVID-19-hit trend growth, the difference is about $12 trillion, he says.

“That’s the economic size of China and it’s the amount of economic output we are losing over the next two years.”

Into this environment, central banks have pumped trillions of dollars’ worth of economic stimulus payouts. Haegeli says there is no question that such massive central bank stimulus payments are needed, saying stimulus leads to asset price inflation “but it will not be able to prevent defaults”.

Fiscal stimulus may not be a magic bullet for all ills, but the ongoing need for more of it is recognised by the five most important central banks: the US Federal Reserve System, the European Central Bank, the Bank of Japan, the People’s Bank of China and the Bank of England.

“Although there has already been a massive spike in central bank purchases this activity has not yet peaked,” Haegeli says.

“If you compare where we are today to the previous peak in 2016, the spike we’re going to see in central bank purchases in the next few months is 3.2 times the peak in central bank purchases in 2016.

“The central bank ‘put’ (a financial contract designed to protect against losses) is definitely alive and it explains why markets are almost back at the levels we saw before COVID-19, especially in the US—these are very powerful forces.

“We needed central banks to become more innovative again.”

But something important is missing: a plan for the orderly exit of government interventions.

“We badly need it,” he says. “If anything is clear from the last 300 to 500 years of economic history, it is that when a government stepped in big time because of a crisis it rarely stepped down.

“So let’s talk about government exits—it’s necessary for dynamic capitalism to be kept alive.”

Call to improve economic trend growth

Policymakers can do even more, says Haegeli. He advocates an enhanced policy stimulus focusing on improving economic trend growth.

The global fiscal stimulus is certainly bigger than ever before, but most of it focuses on credit measures. Haegeli says the majority are liquidity measures to keep companies alive and to preserve the financial capabilities of households when people have lost their jobs. It enables consumers to keep spending.

Spending on infrastructure is also important, he argues, yet the amount of fiscal stimulus geared towards infrastructure spending today is “too little”. Today’s spending represents just one third of the amount earmarked for this in 2008/09, he says.

“A crisis of this magnitude is an opportunity to improve the structural underpinnings of our global economy, and infrastructure spending would definitely help.”

Building on this theme, Haegeli calls for a return to a “sound financial market infrastructure”.

“$12 trillion of negative yielding debt globally is not a good track record. Increasing debt makes the financial market infrastructure less sound, while it also makes the grounds for the next crisis even more of a concern than the current crisis,” he says.

“It’s very important, especially in Europe, to have an orderly debt restructure mechanism, to have insolvency laws being applied in expedience in the manner we saw in 2008/09.”

In 2008/09, the US acted very fast, he says, injecting equity and restructuring the debt with the Term Asset-Backed Securities Loan Facility (TALF) and the Troubled Asset Relief Program (TARP).

“At the time, the central bank worked hand in hand with the treasury, but I didn’t see the same in Europe,” Haegeli says.

In Europe, countries have national solvency laws, but there is no framework to deal with the companies which are receiving pandemic funds. He says that as a result of receiving the funds there is an increase in the average increasing debt.

It’s going to be hard to repay the debt, he adds, and it’s important to keep dynamic capitalism alive.

“We should prevent, at all costs, an increase in ‘zombie’ companies in Europe yet again. That’s why putting in place the ‘bad bank’ approach, a mechanism to support private equity injection via a private market solution, is really important,” he explains. 'Bad banks' are set up to buy the bad loans and other illiquid holdings of another financial institution.

In his call to action, Swiss Re’s chief economist urges policymakers to learn the lessons from 10 years ago and from Japan 20 or 30 years ago, by not waiting too long to deal with non-performing loans.

“Making the post-crisis recovery strong means the right policies. It’s not just the right policies, not just about injecting liquidity, it’s also dealing with the aftermath, and now it’s time to deal with that.”