As GDPs crumble…
With the pause button pressed on nearly half of economic activity in the US and the EU for what is likely to be at least a period of three months, consumption, investment and trade have all collapsed. A contraction of as much as 10-20% of GDP or worse is possible. Pervasive uncertainty about the timing of the development of a viable treatment and/or vaccine means there is no light at the end of the tunnel yet. Even when we get there, the trauma of the COVID-19 meltdown will keep investors and consumers on the sidelines.
…tax revenues will collapse…
This will blow a massive hole through tax revenues. Corporate taxes that derive from profits will collapse first. Sales and value-added taxes will register a dramatic fall in line with the collapse in economic activity. The gigantic scale of job losses and/or job subsidies to stem such losses will depress income taxes. Tax revenues may fall by 30%-40%, maybe more.
…and deficits balloon…
Even as tax revenues dry up, governments need to spend unprecedented sums of money not just on healthcare and social interventions to fight COVID-19, but also on welfare payments and job guarantees. Mortgage and rental market interventions, rescuing and resuscitating private sector firms, even whole industries, and inevitably bailing out large tracts of the financial sector will require record fiscal interventions. The pincer movement of falling taxes and rising spending will drive eye-popping fiscal deficits of 10%-20% of GDP, and beyond.
…leading to counterproductive austerity
The double whammy of crumbling GDPs and ballooning deficits may drive OECD debt/GDP ratios up by 30% or so by the end of 2020 as countries scramble to borrow, mirroring the effect of the global financial crisis and its aftermath. It may push Italy and Japan past the 160% and 270% of GDP mark, respectively, and no country would be immune. Inevitably, this will fuel future calls for austerity, with the counterproductive logic and toxic politics of the EU’s Stability and Growth Pact and Fiscal Compact, driving long-suffering euro area economies further into the ground.
A poisoned political economy
This will strain already fragile relations between member states, possibly to breaking point. But it will also worsen the intergenerational rift. Leaving our children with an unaffordable fiscal burden, on top of a climate catastrophe is not the legacy we wanted, nor one they might be willing to take.
There is one way out
There is, however, one way out that can both deliver the shock and awe necessary to get ahead of the pandemic, and deliver us from counter-productive future austerity, political conflict, and intergenerational schism.
Central banks must break new taboos
And that is for the COVID-19 response to be funded not by borrowing, but through the creation of new money, particularly by OECD country central banks, which include the US Federal reserve, the Bank of Japan and the ECB.