Social distancing, lockdown and quarantine and policy responses

We are now to the point where it’s clear the coronavirus situation will last for weeks and months to come as more and more countries are forced into the lockdown and quarantine approach to slow the virus down. This is a matter of life and death because we now know that the virus is considerably more lethal for the elderly than influenza is. But, the downside of this approach is a massive hit to the economy. And so, now we have to explore potential policy responses and whether they will be enough to prevent a global recession.

Re-reading my early view of the coronavirus

When I write new stuff, I like to go back and re-read what I’ve already written first, just to get a sense of whether recency bias causes me to miss the bigger picture. This newsletter is supposed to be forward-looking and analytical. And it can’t be if I am always navel-gazing and reacting to the latest incoming data as if they’re the only thing that matters.

So, yesterday, I looked back at what I wrote about ‘social distancing’ , what I’ve been calling the ‘lockdown and quarantine’ approach to combatting this pandemic. And I thought it was good enough and relevant enough to repeat here – a self-quote, if you will. Here’s the part I want to concentrate on from February 25th on how government should respond to the threat of the virus:

This is how we want public health officials to act. It’s important to say this because the draconian measures the Chinese are taking are designed to save lives. And by not taking those actions, they would risk the outbreak being more severe and potentially much more deadly. So I would describe this less as ‘fear’ of coronavirus hitting economies and more as ‘justifiable caution’ hitting economies. In my view, fear is what we would see if authorities didn’t do anything and the virus spiralled out of control as a result. People would really be afraid then – and the economic consequences would be even more severe.

For example, just today we learned an Italian doctor vacationing in Tenerife, Spain contracted coronavirus and the immediate response of authorities was to put the hotel he was staying in into lockdown. Lombardy is the region in Italy where the virus has spread and that is also now in lockdown. Isn’t the hotel lockdown measure what we want to see, rather than the hotel guests going back home and potentially spreading the virus even further around Europe? The Spanish are doing the right thing. And it’s measures like this that prevent fear, rather than add to fear.

In retrospect, I believe this was the right framing for how to think about the coronavirus. And I also believe the Trump Administration and Americans more generally failed to take this framing of the problem onboard – and are only now beginning to do so. The countries that have done so the earliest are the ones which have slowed the spread of the virus the most. Whereas countries like Iran that covered up or delayed a response are facing a severe epidemic.

With the Italian situation becoming more severe and the lockdown and quarantine approach going nationwide, we are getting a glimpse now at what awaits the US in best case outcomes. All evidence suggests the US will be hit incredibly hard because public health policy here has failed.

Where are we now?

I was just re-reading my February 26 post regarding containment of Covid-19. And here’s something I wrote then referring to an article in the Atlantic by James Hamblin on the likelihood this becomes a pandemic.

I suggest you read the whole piece because there is a lot more to digest there. But, the obvious implication here is that the lockdown and quarantine approach won’t work. The Lipsitch view suggests that Covid-19 will become ubiquitous; lockdowns and quarantines won’t work. And if they won’t work, then their cost will be for naught.

[…]

I still believe that we know so little about the lethality and transmission of this virus that the draconian response is still warranted. But, at some point, we will move to a different approach. Whether that’s before or after a pandemic can become entrenched remains to be seen.

…But what we can say is that policy makers will face a test: do they relax Corona-virus restrictions before it is clear that a pandemic has been averted or do they risk a global recession in order to break the spread of this disease?

This framing is wrong.

What’s clear now is that:

• a) lockdown and quarantine isn’t about ‘working’ to prevent a pandemic; it’s about slowing the spread of the disease so as not to overwhelm the infrastructure of healthcare systems.
• b) countries are going to take the lockdown and quarantine approach right up until we see infection rates decline. There’s no other politically acceptable posture. Policy makers will do whatever it takes to slow the disease spread and deal with the economic consequences however they can.
• And c) the countries that move to the lockdown and quarantine approach the latest are the ones where the coronavirus spread will be the fastest, and, consequently, where fear and panic will eventually be greatest. The US is at the top of that list.

That’s where we are now.

The policy response in Europe

Monetary policy is always the first port of call because it is the easiest to implement. You have fewest number of political and institutional hurdles to mount a rate cut or two. That’s why we’ve already seen action from central banks; and that’s why people, almost by knee-jerk now, think of central banks and monetary stimulus whenever there is an economic disruption.

But monetary policy operates primarily through the interest rate channel. And that means its impact is not only felt first and most acutely in the financial economy, not the real economy, but that it also that its full impact in the real economy is lagged. Basically, if we want and need an immediate economic boost, we’re not going to get it from monetary policy alone.

That means we have to think about fiscal policy. And this is, unfortunately, where politics, disagreement, and dithering come into play.

For example, in Europe, the fiscal rules are tight but violable in an emergency.

• Is this an emergency, and if so, what fiscal rules can be broken and by how much?
• Is it fine for the Italian government to sanction a mortgage payment jubilee while a lockdown is in place?
• And what happens to Italian banks then? Are they eligible for a bailout?
• Is Deutsche Bank in Germany then eligible for a bailout?
• Can the Italian government temporarily run up deficits as high as 10% of GDP?
• If so, how will the bond markets react and what will the ECB do to mitigate the impact in those markets?
• Does Greece qualify for ECB bond purchases if its sovereign debt comes under attack and sells off?

These are real questions that we may face. And the answers aren’t clear. And the potential for a major policy mistake is higher.

What should the US do?

In the US, there are fewer hard constraints since the Federal government is a currency issuer, not a currency user like eurozone governments. But, still, there are lots of questions.

• How much stimulus is warranted? $10 billion, $100 billion, $1 trillion?
• Who gets the stimulus and how is it delivered? Do we give a payroll tax cut to business and individuals for example? Do we give a general tax credit to provide stimulus?  Or do we credit accounts?
• Do we offer bailouts? If so, to whom – those ordinary Americans immediately affected by the virus or small and medium-sized businesses or large corporations in industries like the airline industry, travel companies, energy companies, banks and the like?
• Does the federal government help people who have no sick leave by giving them financial assistance or payments forbearance? And do we require companies chip in?
• Does government force firms to extend policies for workers to part-timers and individual contractors who have no formal benefits? Does the federal government pick up the tab?
• Does government force healthcare providers to pay for not just the cost of coronavirus tests but of hospitalization and quarantines?

That’s just a sample. There are plenty of other questions here too. But, in a hyper-partisan political environment, these aren’t just economic or public health questions, they are political ones as well. And that increases the likelihood of dithering and policy failure.

My view

In some senses, we’re in the eye of a health and economic crisis storm. The feeling I get is that the market panic has died down somewhat as it has become clear there will be some policy response. And so, even though it’s still unclear what that response will be and how large, the mere fact that it is now 100% clear that governments will respond with stimulus makes market volatility that much lower.

But, we have yet to hit the wall of coronavirus infections and deaths that awaits. And this is going to overwhelm our healthcare system and precipitate serious lockdown and quarantine measures. We are facing a crisis like we haven’t seen in our lifetimes.

Italy is just two weeks ahead of the US. In the next couple of weeks, I believe conditions in all Western democracies will rival Italy’s or be worse – depending on the laxity before lockdown and the preparedness of the healthcare and economic system. And the US will be amongst the worst hit.