2020 / Covid-19

From an economic perspective 2020 will go down in History for obvious reasons : the economic consequences of the Covid-19 pandemic. However it will also go down in History because we have entered a new era. And there are at least four dimensions which justify making the point that we have entered a new era.

The first dimension is the supply side. We can argue that indeed the supply side has taken center stage this year. This is in a way something profoundly new. Normally, when conducting macroeconomic analyses, the focus was entirely on the demand side : what is happening to consumer spending to corporate investment or to exports. With the pandemic and the lockdown, the emphasis really shifted towards understanding to what extent the supply side was being disrupted and was actually stopping companies from producing their goods and services. In addition to that, the Covid-19 pandemic had of course a host of consequences for the supply side. There is the disruption which I have already mentioned, but another important consequence for the supply side was that it led to a reassessment of the quality of the global value chains. Global value chains over time had become very long and also quite complex and perhaps too concentrated and the Covid-19 was a wake-up call that the length and complexity and the  concentration needed to be reassessed .

Another consequence of Covid-19 was the necessity to kind of kicking the tires and to test the resilience of the supply side in the economy. Resilience with respect to health shocks, but by extension, you could argue that security attacks or even climate events would be other threats to the supply side. And I think having been exposed to that disruption related to Covid- 19 is something that has allowed companies to test the resilience of their business models

Another aspect of entering into a new era is fiscal policy. We can say that fiscal policy has now taken over the driving seat. For many years we were in a situation that monetary policy was considered as being the only game in town. That has evolved and the reason why it has evolved is that it seems that we have reached the limits on how much of an impact monetary policy can have on the economy.

Indeed we observed that real interest rates have turned negative in many countries and nevertheless demand is insufficiently dynamic for reasons that we all know : the bleak outlook, uncertainty etc . But the implication is that by easing more monetary policy you cannot have a big bang for your buck anymore or not as big an effect as one could have when interest rates were still positive in real terms. The implication is that the role of monetary policy in a way has evolved and we could argue that is now more conducted in a coordinated way with fiscal policy.

You could almost say that monetary policy is now supporting fiscal expansion. And fiscal expansion, which is another word for budget deficits, has increased fairly significantly. It is sufficient to look at the sheer scale of the intervention in terms of income support that has been provided or guarantees that have been provided for companies and businesses for the loans that they have taken on.

Fiscal policy has also been very important as an effort to try to directly influence income and thereby spending decisions by households or companies but also directly impact demand by putting forward the prospect of increased investments in infrastructure.

Another important element of being a new era with respect to fiscal policy is of course the challenge that is upon us and it is a truly huge challenge : how can we go about in trying to engineer a trend-wise decline of public sector indebtedness once that economy will have recovered sufficiently from the pandemic.

The third dimension of entering into a new era in 2020 concerns central banks. Central banks that have seen a broadening of their remit and or a change in objectives or even a re-prioritization of objectives. To illustrate these points let’s start with the United states : the Federal Reserve. Three elements there. First of all the Federal reserve in the context of its strategy review has decided that going forward, it will target average inflation. That means that it will accept a moderate overshoot of inflation over its two percent objective. The second important change for the Fed, has been the possibility that has been created to buy corporate bonds. That has been of fundamental importance in stopping the disruption in the corporate funding markets and hence has been instrumental in supporting the economy via that intervention. And the third area of change is that the Federal Reserve is now also focusing very strongly in the conduct of its monetary policy on inclusive growth by allowing the unemployment rate to go down and no longer to tighten preemptively when a certain low level of unemployment would have been reached.

That is for the Fed. What happens on the side of the ECB ? Two important things. First of all is the introduction of the Pandemic Emergency Purchase Programme : quantitative easing to be really adapted to the needs caused by the pandemic. The crucial importance of the PEPP cannot be underrestimated. It is absolutely of fundamental importance and a key aspect of that programme is of course the flexibility that it provides. Flexibility why ? Because the capital keys are no longer acting as a constraint on the allocation of the purchases over the different sovereign issuers. Another important idea of change for the ECB is its increasing emphasis on its willingness, keenness, to introduce climate change considerations in the conduct of its monetary policy. And that is why we are eagerly awaiting the outcome of its own strategy review which will be communicated in 2021.

The fourth dimension of entering a new era concerns sustainable growth. I would argue that that dimension is mentioned the last but certainly it is not the least important one. Quite to the contrary. What is striking when we look at everything that has happened in 2020 is that how often climate change and sustainability are an attention point or a point where relationships can be identified with the events that have marked 2020.

One point to illustrate that : when we’re talking about health risks and viruses, we immediately think about the relationship between global warming and virus development risk. The second illustration is supply side disruption. Supply side disruption, as mentioned earlier, has been a key characteristic of the pandemic and is also mentioned before climate events are another factor that can trigger disruption in the supply chains of companies. The third aspect is fiscal policy. We have seen in Europe and this should be welcomed of course immensely,the initiatives that are being prepared in the context of Next Generation EU, the 750 billion fiscal stimulus programme, have a very important climate change related dimension, sustainable growth related dimension. It is a matter of trying to kill two birds with one stone. The economy needs support at the same time. Society needs to be put on a path of sustainable growth and on a path of keeping a lid on global warming. Let’s try to do the two things jointly by allocating the money to invest in projects that serve the purpose with respect to the climate and the environment. And finally, as far as central banks are concerned, again we find a relationship with sustainable growth. The relationship comes in terms of the increasing focus on climate risk, that is from the role of central banks, s as supervisors and regulators. But also, as seems to be the case with respect to the European Central Bank, increasingly thinking about incorporating climate change, ambitious into the conduct of monetary policy.