Public debt levels will have increased. But the alternative—a permanent destruction of productive capacity and therefore of the fiscal base—would be much more damaging to the economy and eventually to government credit. We must also remember that given the present and probable future levels of interest rates, such an increase in government debt will not add to its servicing costs.
— Mario Draghi, Financial Times, 26 March 2020
The reaction by policymakers in the U.S. and the U.K. to the coronavirus outbreak has in many ways paralleled what happened in the film Jaws. In the film, Police Chief Brody rushes to close the beaches after the first attack. But Mayor Vaughn, who refuses to acknowledge the scale of the problem, overrules him and prematurely reopens the beaches so as not to miss the commercial opportunity of the July 4 holiday weekend. For those who have watched the film, this ends with tragic consequences. The film also contained plenty of fake news and advice from numerous "experts," up until when the gravity of the situation finally came into focus and an appropriate response was undertaken. Today, the U.S. and the U.K. continue to wait to see how this pandemic will play out. The U.S. is still several weeks away from the peak rates of infection, though developments in China—it is starting to re-normalize—are certainly encouraging. What is also encouraging is that in the past week, both Congress and Parliament have voted to at least provide "a bigger boat," in the form of substantial emergency assistance; however, prematurely "reopening the beaches" could turn out to be a major error of judgment in light of what's happening in many parts of Europe.
Last week, we discussed where we were in the current crisis with respect to the seven stages of grief, with the view that we were moving out of the panic phase and into the response phase. The behavior of financial markets this week seems to be in alignment, as the market is getting a better handle on the scale of the crisis and the scale of the policy response to it, and, thus, starting to adjust accordingly.
This is, for the most part, still believed to be a temporary crisis, and given that the virus has still yet to peak in many parts of the globe, it is far too soon to have any certainty about the longer-term implications of COVID-19. Nevertheless, it might not be too early to speculate as to what some those outcomes might be. In this week's Economics Weekly, we discuss what are being viewed as two possible outcomes—accelerated deglobalization and higher government debt levels.
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Richard de Chazal, CFA is a London-based macroeconomist covering the U.S. economy and financial markets.