The COVID-19 crisis will leave many private and public borrowers saddled with unsustainable debt. We are still in the “pre-Keynesian” supply-shock-cum-derived-demand-shock phase of what is likely to be a global depression. But once the virus is mostly vanquished, households will engage in precautionary saving, and businesses will be reluctant to commit to capital expenditures, driving a further decline in aggregate demand – the Keynesian phase. Deficit-financed fiscal stimulus, monetized where possible, will probably be the only tool capable of closing the output gap.
As the issuer of the world’s dominant reserve currency, the United States faces fewer constraints than other countries on the federal government’s ability to borrow and to monetize public debt. Its economic-policy response so far – the Coronavirus Aid, Relief, and Economic Security (CARES) Act – earmarks $2.3 trillion for income support, grants, loans, asset purchases, and other guarantees. According to the Congressional Budget Office, the legislation will increase the federal deficit by “only” around $1.7 trillion over the next decade. The difference reflects the $454 billion set aside to fund guarantees for emergency lending facilities established by the US Federal Reserve, on the assumption that these guarantees will never actually be called upon.
If only it were so. Another $3 trillion fiscal bill, recently passed by the Democratic-controlled US House of Representatives, will likely be adopted in some form by the Senate, and still more stimulus may follow after that. Lawmakers are realizing that, even in the US, many state and local governments will not have the means to weather the crisis without the benefit of debt and loan guarantees or direct transfers from the federal government.
What’s true in the US is true everywhere: government programs to support economic activity will lead to an explosion in public debt and private debt owned by the public sector. In the eurozone, an existential crisis is looming, owing to a controversial recent ruling by Germany’s Federal Constitutional Court and the unwillingness of the eight New Hanseatic League member states to contemplate public-debt mutualization. The European Union’s new €240 billion ($263 billion) Pandemic Crisis Support mechanism is small potatoes, amounting to just 2% of eurozone GDP. Without more EU support, Italy may soon face the unpleasant choice of crashing out of the euro or remaining in without being allowed to implement the fiscal stimulus it needs.
To be sure, a new Franco-German proposal envisions a €500 (3.6% of EU GDP) European recovery fund, to be financed through capital-market borrowing by the EU (whose annual budget barely exceeds 1% of the bloc’s GDP). It is unclear how much of these funds are truly additional and over how many years they would be spent. If these funds were provided to fiscally challenged member states in the form of grants, as the French and German governments favor, that would amount to debt mutualization, raising the possibility of a veto from the New Hanseatic League. But if the European Commission were instead to issue loans to member states on market terms, Italy could find itself on a fast track out of the eurozone.
Fortunately, there may be another way forward. Across most advanced economies, much of the additional private debt accumulated during the crisis will likely end up being owned by public entities, including central banks, and most of it will never be repaid. To protect their independence and political legitimacy, central banks should not act as fiscal principals. And yet, in the case of small and medium-size enterprises, it is simply obvious that COVID-19-related debt will have to be forgiven. The national Treasury will need to compensate the central bank for any losses it incurs.
For publicly traded companies the debt held by public creditors should be turned into equity, in the form of non-voting preference shares, which would minimize the impression that the pandemic had inaugurated a new era of central planning. Again, the national Treasury will have to indemnify the central bank for any losses it incurs. An equitization option should be attached to all newly issued public debt. The resulting equity instruments could represent claims on part of the government’s primary budget surplus, or their interest rates could be linked to GDP growth.
But poorer countries will not have this option. According to the Brookings Institution, emerging markets and developing countries already owe about $11 trillion in external debt and face $3.9 trillion in debt-service costs this year. In April, the World Bank and the International Monetary Fund offered a modicum of debt relief to many of these countries, and the G20 agreed to a temporary payment standstill for official debt, which paved the way for hundreds of private creditors to do the same.
Yet these forms of assistance offer too little, too late. The fact is that most of these debts never should have been issued in the first place. Grants are the proper way to transfer resources to low-income countries. After World War II, the Marshall Plan involved only grants; today, the case for “corona grants” to low-income countries could hardly be stronger.
Under the IMF and the World Bank’s 1996 Heavily Indebted Poor Countries (HIPC) initiative, some 36 countries received full or partial debt relief. It is time to return to that idea, starting with a comprehensive round of debt forgiveness for the world’s poorest countries. This selective jubilee should include debts owed to the IMF, the World Bank, other multilateral lenders, national sovereigns, official bodies like state-owned enterprises, and private creditors.
Debt is a dangerous instrument. For far too long, the world has used it to avoid awkward but unavoidable decisions. In the midst of an unprecedented global crisis, something will have to give.
Willem H. Buiter, a former chief economist at Citigroup, is a visiting professor at Columbia University.
Copyright: Project Syndicate, 2020.
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