During the acute phase of the crisis, fiscal policy should focus on safeguarding companies’ liquidity and preventing bankruptcies and mass unemployment. In order to succeed, the measures taken should be timely, extensive, targeted, and time-limited. In the second phase, it will be time to launch a conventional fiscal stimulus. If the fiscal policy has succeeded during the first phase, it is highly likely that, in the second phase, private consumption and exports will give a strong expansionary impulse to economic activity. This article is part of a series of blog posts dealing with the economic impacts of the coronavirus.
Fiscal policy must be timely, extensive, targeted, and time-limited. As long as the restrictions imposed remain in force in Finland and its major trading partner countries, fiscal policy will be unable stimulate the economy by conventional measures, such as construction projects (e.g. because of availability problems) or tax cuts targeted at households. This is because both supply and demand have weakened and are unable to react to the stimulus. Coordination between trading partner countries and the EU countries, in particular, is important not only in fiscal policy but also in the case of restrictions, which have negative externalities on the economies of neighbouring and trading partner countries. The restrictions have, nevertheless, positive externalities on the spreading of the infectious disease and the strain on the health care system. This applies particularly to Finland, which is a small open economy.
Until the restrictions are lifted and the exponential contagion phase is over, fiscal policy can only adapt to the crisis and the temporary decline in GDP. This does not mean that fiscal policy has no role during this phase – on the contrary. Fiscal policy has two vital roles.
First, it must safeguard the liquidity of companies and indirectly also of banks. As a result of the crisis and the restrictions imposed, many companies that are otherwise in good condition and have a profitable business model will face problems. This is because, for example, deliveries from abroad are delayed, the number of customers falls as a result of the travel ban, customer companies are unable to pay for their orders, or a place of business must be completely shut down on account of the restrictions. The loss of cash flow weakens companies’ liquidity and creditworthiness, which, in turn, may cause banks to apply more prudent lending practices. This should be addressed by means of parliamentary loan guarantees and loans. In addition, monetary policy measures can have a positive impact on the situation. The Government has responded to these questions by, for example, increasing Finnvera’s financing volume.
Second, fiscal policy must ensure that companies will not strive to maintain their liquidity mainly through redundancies. Research findings show that recession increases structural unemployment. Short-term unemployment becomes long-term unemployment, which is what happened during the 1990s recession. However, the most difficult situation is likely to pass quickly, and after the crisis, companies would have to find new employees to meet the growing demand. This would slow down the catching up of the lost production. Unemployment benefit would at least partly safeguard households’ liquidity and serve as an automatic stabilizer, but it is unable to minimize unnecessary recruitment costs and weakening of human capital in the longer term when the acute crisis is over. Fiscal policy should make it possible to apply layoffs and shortened working weeks widely, and it should also temporarily bear a share of payroll costs. The Government should also support the livelihood of entrepreneurs and self-employed persons as well as the conditions for self-employment. In Germany and Switzerland, these kinds of measures proved to be efficient during the financial crisis, and they are widely used again in the present situation. The Finnish Government is currently involved in tripartite negotiations to find measures to influence the overall situation. The faster the measures are taken, the better.
Fiscal policy should aim to give confidence to both the market and the citizens
In addition to playing their two most important roles, policies – and fiscal policy, in particular – should strive to give both the market and people confidence in that central government and public authorities are making all necessary efforts to solve the crisis. Psychology has now a strong hold on the market, and it is vital that the fiscal policy takes this into account. Based on this logic, it would be justified to promise a crisis package, theoretically of even an unlimited size, as for instance Germany did.
This policy involves many risks, and it is very likely that some of them will materialize: e.g. parliamentary loan guarantees may be realized. In this respect, however, the Finnish public authorities are relatively well placed, as the public debt burden in Finland is sustainable at least in the short term. Fiscal policy should also prepare for rapid growth of debt (particularly relative to GDP) as a result of the crisis. This underlines the importance of countercyclical fiscal policy even in boom times, as this provides sufficient fiscal leeway in the event of a crisis.
Finally, there are yet two other dimensions connected with the current situation and the fiscal policy it calls for. First, although Finland’s fiscal leeway can be regarded as considerable, the same does not necessarily apply to the other EU countries, such as Italy, where stricter restrictions have been imposed, and where the health care is overburdened. It is not far-fetched to say that this may cause such uncertainties in the euro area that must be addressed.
Second, it is very difficult to estimate at the moment how long the crisis will last. The restrictions may continue to be in force after 13 April, and the economic shock will not be limited merely to the first quarter. Fiscal policy should prepare for this. Even if Finland managed to control the spreading of the disease and could gradually start to lift the restrictions, conventional economic stimulus might be challenging or even wasted if restrictions continued to be in force in its neighbouring and trading partner countries.
Household consumption can be boosted by fiscal policy measures only when the exceptional circumstances are over
Once the measures limiting private consumption and production have been mitigated or removed, it may be time to start conventional stimulation. This would enable both market participants to react to the stimulus. The EU countries should coordinate the stimulus measures to the extent possible, as fiscal stimulus in one country is likely to have significant positive externalities on other countries as well. The stimulus measures should also be planned carefully in advance so that they can be introduced as soon as the time is ready.
It would also be important to consider whether conventional stimulus measures should be limited in both size and time. People are now postponing their consumption. When the acute crisis is over and the restrictions are lifted, private consumption is certain to give a strong expansionary impulse to the economy. This will obviously require that the measures previously taken succeed in preventing mass unemployment and mass bankruptcies so that production can respond to the growing demand once the crisis is over. For the above reasons, measures taken during the acute phase of the crisis can be considered of vital importance for economic recovery. The better the fiscal policy succeeds in preventing mass unemployment and bankruptcies, the faster and less expensive it will be to reach an economic upswing.
It should be noted that part of the consumption, especially of the consumption of services, cannot be postponed – it has simply been lost and cannot be caught up. At least the wellbeing sector will suffer from this kind of permanent loss of income. When private consumption starts to grow again after the crisis, it is also likely that it will not be directed evenly to all industries and will therefore not equally offset lost sales. However, when the crisis and pandemic are over, consumption and exports are expected to grow rapidly, driven by the consumption of households and the trading partner countries. Market psychology may then strongly promote the economic recovery, although it is currently doing the opposite.