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What shape recovery?

Summary:
Will the recovery be V shaped, quickly roaring back to the previous level? It does that every January 2 after the long Halloween-Thanksgiving-Christmas-New Years slowdown, and it did in 1984. Or will it be an agonizingly slow U or L shape, as the recovery from 2008 turned out to be?I had early hope for a ...

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Will the recovery be V shaped, quickly roaring back to the previous level? It does that every January 2 after the long Halloween-Thanksgiving-Christmas-New Years slowdown, and it did in 1984. Or will it be an agonizingly slow U or L shape, as the recovery from 2008 turned out to be?

I had early hope for a V, but a fear that shuttered businesses and permanently fired people would turn it into an L. Those take much more time to reorganize. Hence, lots of blog posts advocating a more nuanced policy than a blanket lockdown.

But now I think it's clear the virus will not end with a sudden all-clear, like January 2 or an air raid. If, as we all hope, the current unbelievably costly lockdown does its job, we will in a month or two emerge with the curve bent, a stable or declining number of cases. But the vast majority of the population will still not have been exposed. We will not have "herd immunity" -- and a good thing too as 1% of the herd will not have died to get there. And cases both home and abroad will not be zero.

Nothing short of a cheap, effective, incredibly safe vaccine given to just about everyone on the planet will change that.

That means the virus is ready to reemerge promptly. All it takes is one person to travel to a town, go to a restaurant or club meeting, wait two weeks, and you have an outbreak all over again. We will have hotspots and flare-ups needing intense testing, contact tracing, local lockdowns, travel restrictions, and so forth -- if our bureaucracies are finally up to the task of doing anything competently.

On the individual and public health level this means almost all of us -- who have not gotten it or don't trust that you can't get it again -- will be practicing some sort of social distance for a long time. And, getting to the point, this all suggests a period of very slow economic activity. I don't want to call it "recession" as that word implies simple lack of aggregate demand, the Keynesian uni-causal story. No amount of printed or borrowed money will get the social distance economy going again.

Ross Douthat nicely sketched a picture of the coming economy in the Sunday NYT:
Life at half capacity: Right now our institutions must survive while essentially closed — with few or no customers, moviegoers, travelers. But soon they will have to figure out how to reopen while maintaining the social distancing that semi-normalcy requires.
... fewer people will come out, and because there will be rules governing how many people can come in.
...the scenes at some grocery stores right now, the line of people six feet apart waiting to come inside and shop, may become a permanent feature of the semi-normal landscape. Churches will hold services with every other pew occupied. Restaurants will seat every other table. Planes could fly without a single middle seat occupied. Sports may resume without spectators, relying on TV revenue alone.
Ross doesn't fully draw the economic conclusions of this vision. Such grocery stores can only serve a fraction of the number of customers, yet need more employees and still have to pay the rent. Such restaurants make half as much money yet still must pay the rent. Such airlines still pay the pilots, flight attendants, fuel, and larger cleaning and disinfecting crews. This is not a sustainable economy -- at today's prices.

Ross turns to the government
And since the flow of money and custom and attendance won’t come close to what existed just a month ago, any government response will have to be calibrated to a half-capacity world — where institutions are technically open for business, but they still need help to stay alive.
I have bad news. The government is also a limited resource. We cannot go on for months on end with the government paying half the bill of everything. Just who is buying all those government bonds? With what income? A trillion dollars a month adds up.

The answer is, this is an enormous negative supply shock, together with a big shift in demand. If only  half the seats can be filled, running an airline just got twice as expensive. If only half the tables are filled, running a restaurant just got twice as expensive. Those prices have to double. Which in turn, will drive customers away, towards driving (RV sales should go up), cooking at home, fancy takeout, and so forth.

There is likely also to be a shift towards precautionary savings. I think lots of people and businesses have figured out that keeping some cash or money market investments around is a good idea, and overall appetite for  risk is going to be lower. I diagnosed markets as suffering from a panicked demand for cash last month. But the standard business cycle mechanism of lower "risk appetite" makes a lot of sense. The shift towards a desire for safe investments may also keep markets low for a long time. This is the standard business cycle mechanism. (Don't think about saving vs. investment. Think about desire for risky vs. safe investments. Business cycles are about risk premiums.)

Torsten Slok writes by email (summarizing gated DB research) suggesting
Increase in precautionary savings for households... More space between seats at restaurants, cinemas, sports events concerts, conferences, trains, buses and airplanes. Fewer people traveling on vacation and going out... Older generations staying at home, less willing to put parents in retirement homes. Limits on the numbers of people un supermarkets, more online shopping, more online doctor visits. Fewer people going to fitness centers, doing group sports. More people driving their own car to avoid public transportation. 
Aside. This could be the kiss of death for public transport in the form of busses and trains. If there is anything that cannot stand a doubling of its cost, and attendant decline in demand, that's it.
Less business travel.. more video conferencing... fewer buybacks, lower dividend payouts  [more equity less debt] 
and, I am not alone worrying
more supply of government bonds, increasing risk of a debt crisis.  
Policy will face the usual cruel tradeoff: The more help you give the unfortunate, the more disincentives, and the slower the recovery. Noah Williams writes perceptively of unemployment expansion (which, whatever its faults, is probably the best of the government's responses -- better than cash payments to everyone which will arrive late summer, better than bailouts for airline stock and bondholders, and municipal bond holders)
the program is poorly designed. It provides incentives for employers to lay off workers. In the future—assuming the pandemic restrictions are lifted before August—it will discourage people from returning to work.
The current federal relief package extends unemployment benefits to 39 weeks, plus additional payments....Under the new expansion, the average replacement rate across states would increase to roughly 116 percent 
You're running a business. You have some cash around, and could keep people on, at least at reduced hours and health insurance. If you fire them, though, they can get 116% of their salary from the government, and Obamacare. It's a no brainer.

There is good news in this however. It means that much of what looks like unemployment may really be furlough. The people and employer know where each other is and can snap back more quickly.

39 weeks of 116% of salary though gives people little incentive to answer that phone call. Especially while schools are closed, day care is closed, and gardeners aren't allowed to come around.

Moreover, there is already a shift in demand -- to cleaning crews, online services, and so on. Paying people to sit at home makes sense in the lockdown. But much less in life at half capacity -- and rapidly changing -- economy.

This seems heartless, but it is brainless to ignore that there is always a tradeoff between help and incentives. The last recession and half-hearted recovery was a chaos of bad incentives. Noah:
In general, unemployment-benefit programs try to balance insurance with incentives, seeking to provide relief when needed while also offering motivation to look for work. States typically require recipients to search for a job. Setting the replacement rate well below 100 percent is usually a strong encouragement for them to do so.
Covid-19 presents unusual circumstances because unemployment has been enforced by government decree. Much of this joblessness will likely be temporary, with workers rejoining their employers once the pandemic subsides and restrictions are removed. Further, while some employers (Amazon, Walmart, grocery stores) are adding jobs, most companies are, at best, putting a freeze on hiring. The disincentive effect of unemployment benefits in the current crisis is minimal, while relief needs are large; thus, Washington has increased benefits, and many states are waiving job-search requirements.
Policymakers should be wary, though, of implementing relief provisions that will delay economic recovery, as occurred during the Great Depression and the 2008–2009 Great Recession. The Federal Pandemic Unemployment Compensation program is time-limited, but if the shutdown ends within the next four months, the aggressive unemployment-benefit replacement rates well in excess of 100 percent would hamper the labor market’s recovery.
In short, great generosity makes sense in the lockdown, but must be much more carefully calibrated if we do not want an L shaped recovery.

And emerging chaos at unemployment offices and small business administration suggests the help may come just as it is no longer needed.



John H. Cochrane
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!

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