The big spend up - how governments will save the global economy from COVID-19?

09 April 2020

Written by kōura

Economies worldwide are suffering due to COVID-19 and the resulting lockdowns. Governments are stepping up to support the economy as we’ve never seen before.

All around the world economies have suddenly suffered a big shock. Everything has come to a halt, and it’s down to governments to keep them going. Economies only keep running as long as the money keeps circulating. With most of the world in lockdown, money has essentially stopped flowing. People are at home and not working or spending. Without the flow of money, businesses go bankrupt and workers are made redundant. 

So governments need to step into the breach and help start money flowing again.  They do this by giving money to businesses and to protect jobs or give money directly to consumers to start spending.  Their goal is to pump as much money through the economy as they think is necessary to limit the damage by the shrinking of the economy.  This is called a fiscal stimulus.

We saw fiscal stimulus used during the 2009 global financial crisis, but COVID-19 has seen stimulus packages announced like never before.  The stimulus announced to date is significantly larger and have been announced earlier in the crisis than were announced in 2009.

What has been announced?

Fiscal stimulus packages announced (As a % of GDP)

Fiscal stimulus packages announced (As a % of GDP)

 

So far, more than NZ$9 trillion in stimulus packages has been announced worldwide. Some of the packages include:

  • The US stimulus’ massive US$2.3 trillion. That's almost three times the stimulus provided during the 2009 financial crisis. It includes immediate cash payments of $1,200 to most Americans. It also helps with unemployment benefits, emergency loans, and grants for small businesses.
  • In Europe, the EU has pledged a €37 billion spending programme. It’s also letting eurozone countries run a greater deficit than the 3% cap usually imposed.
  • Australia has one of the largest packages announced so far. It includes business loan guarantees, wage subsidies, income support, and cash flow support.
  • The UK has brought in a £300 billion package. It will go towards a job retention scheme, compensating for sick workers, and loan guarantees for small businesses.
  • New Zealand’s brought in a $12.1 billion package. This includes support to some hard-hit industries, like tourism. It also includes a wage subsidy and leaves scheme to help businesses keep paying their employees.

 

Where does the money come for this spending?

All this extra spending will be funded by government borrowing. Governments worldwide borrow lots of money. This latest round of stimulus means they’ll need to borrow even more. 

Luckily, the normal rules of borrowing often don’t apply to governments. If we went to the bank, there’s a cap on how much we can borrow. The more borrowing we do, generally the more expensive it is. It’s not really the same for governments.

Government bonds are seen as very safe assets. In times of economic turmoil, investors look for somewhere safe to put their money. Government bonds are generally as safe as you can get.

If investors don’t want to lend money, there’s always the central bank. They have the unique ability to create new money. Sometimes this is referred to as “printing money”. Central banks can use this new money to buy government and corporate bonds. This is called quantitative easing (QE). Central banks can lend money without limits for as long as it’s necessary. By buying up bonds it reduces the long-term interest rates. Interest rates will reach a level that encourages money borrowing to spend and invest.

QE might sound familiar. It was used during the global financial crisis and the eurozone crisis. Aggressive QE by the European Central Bank in 2011–’12 is credited with saving the Euro. 

New Zealand is about to have its first round of stimulus. The Reserve Bank will buy $30 billion of government bonds over 12 months. They’re seeking to buy $750 million of bonds per week.

 

Does the money have to be paid back?

Government debt as % GDP

Government debt as % GDP

This money will need to be paid back over time. We'll need to restrict future government spending or increase tax levels so we can repay this extra spending. 

Some governments already have low levels of debt - this will have given them flexibility and dealing with the extra debt will not be a significant issue for them. New Zealand is a good example. For countries like New Zealand, repaying the stimulus won’t be a major issue.

Countries with higher debt could be facing some tough choices in the years to come (cuts to Government spending or higher taxes). We saw this play out in Europe following the Global Financial Crisis where many countries faced a lost decade of austerity (difficult cuts to social services and higher tax) in order to repay the extra debt that was taken on during that crisis.

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