OF Discussion Board n°6 – 26 June 2020

Question asked : „Staggering amounts of money start pouring on Western economies in order to keep the economic machine working and to avoid massive social shocks and unrests. How will this effort be financed? First step is clear: public bodies will issue debt and borrow on the markets, while central banks will pump liquidity to make the deals easier. The second step is less clear: what should the governments do to allocate these massive amounts: give away by distributing to the affected households or enterprises (helicopter money); lend them and ultimately either enforce the service and reimbursement conditions or cancel the debt; or should they provide equity to enterprises as would do an equity (sovereign?) fund, and expect future dividends – and for the big enterprises the stock price hikes – to cover, in due time, the incurred expenses?

Thanks for those of our contributors who ventured to react to the this question posed in this Discussion Board.

V. A.


Editorial – Indulgent creditors and industrial policy
by Virgile Perret & Paul H. Dembinski

“Objectives of rescue programmes should have priority over the mechanisms of financing”. But objectives are many, they are simultaneous and not necessarily converging, some are short term other long term: “support to households and firms”, “increase demand”, “green energy transition”, “long term sustainability” etc.  So there is not a “single one size fits all” policy mix to be applied across the globe. Available measures have to be balanced against their impact on the various socioeconomic groups, because, for instance “the way debt is cared for (or cancelled through inflation) directly affects inter-generational contrasting interests”.
A distinction has to be made between measures helping needy households and those supporting firms and the future economy. For the former, “help – for instance through stronger unemployment benefits or financial compensation for reduced working time as in Switzerland – should be provided with no requirement on payback.” Households may also be supported through more unconventional policy options such as helicopter money even if the US experience seems to have been a failure “2/3 of the sums allocated were not spent!”
On the firm side, the challenges is to target those firms “that face a temporary drop in income, but are otherwise viable, without subsidizing firms that are fine anyway.” Such a support could take the form of loans with low interest rates and long maturities, with the option of a write-off of debts backed by governments or their ultimate conversion into firms’ equity. Thus, at the end, there will be a request for an “indulgent creditor”.
To complicate matters further, many of measures seem to be geared toward short-term business cycle-like goals. These however do not address the structural dimension, namely the sectoral and environmental urgencies, the long-term sustainability and transition to a green economy.  Thus, depending on countries, more radical measures may be envisaged to support industries of strategic importance (e.g. in Europe the automobile), such as “recapitalization, or even partial nationalization”.
In other terms, the appropriate policy-mix in the long term financing may require the comeback of “industrial policies”, banished long ago in the name of market discipline and free competition. The old question will thus come back again: can industrial policy avoid creating massive market distortions?

… the objectives of rescue programmes should take priority …”

All the categories mentioned are likely to be deployed as part of extensions of public budgets and of fiscal interventions in response to the Covid-19 pandemic. The distribution of the additional financing in particular jurisdictions will be determined according to the incidence of crises, the functioning of central and local government institutions regarding revenue and expenditure, and the relation of monetary policy and financial markets to this functioning. Separate mention might be made here of potential recourse to perpetuals – bonds with no maturity and a low but positive interest rate which could assist the avoidance of potentially catastrophic effects of long-term zero or negative rates for pension funds. Generally the objectives of rescue programmes should take priority over mechanisms of financing since countries will devise their financial and fiscal means one way or another.

Andrew Cornford

… economic machine and the prognoses that it implies …”

While apparently complex, an economy is really just many simple things working together, including all of the transactions in all of its markets which make it look more intricate than it really is. In any market there are lots of buyers and sellers, having different motivations. This perspective of supply and demand is different from the traditional perspective in which both supply and demand are measured in quantity and the price relationship between them is described in terms of elasticity. Therefore, prosperity would be easy to achieve simply through pursuing policies that would gradually increase demand and in credit based economy, robust demand equals robust real credit growth; conversely, deleveraging equals low demand, and hence lower and falling real credit growth.

Archana Sinha

… inter-generational contrasting interests …”

Macroeconomic experts – which I am not – will ponder pros and cons of different funding solutions. This is important as large parts of savings and retirement funds are invested in public debt, and the way debt is cared for (or cancelled through inflation) directly affects inter-generational contrasting interests. Whether the amounts raised should be given, lent or invested in equity is a subsidiary question to what the money is used for: emergency temporary aid? Or driving people, institutions and companies towards productive work and equal opportunities? The key criteria for public spending/investing should aim at green energy transition; education for technological change and personal capacity for ethical and cultural discernment; technological developments which are labour enabling (instead of labour replacing).

Domingo Sugranyes Bickel

… solidarity is key …”

Governments are fiduciaries of society. Their borrowing from future taxpayers is sociologically a wicked problem. Well-governed allocations need to include benefits to this future generation and correct for material societal problems unresolved by the current generation. Solidarity is key and any decisions should include deploying all economic tools available and appropriate. These include regular debt servicing where feasible, debt cancelation to enable sustainable development, debt-equity swaps to recognize governments run higher level of risks, some level of inflation in line with labour market priorities and responsible national budgets, industry structure reform, some level of central bank access for all, which increases financial system stability, and overhaul of fiscal systems enabling a just redistribution of wealth to correct for excessive disparities.

Eelco Fiole

… it could be useful to build a two pillar strategy …”

There is probably not a single “one size fits all” solution on how better allocating massive amount of money to Western economies in the frame of the Covid-19 pandemic. In Italy, for example, a task force for economic recovery headed by Vittorio Colao, developed a plan for 2020-2021 which mostly envisages the private sector as the main focus of the recovery. Consequently, it could be useful to build a two pillars strategy. Italy could (1) develop a sovereign fund investing in enterprises, with some clear prerequisites; alongside the private sector, (2) an important part of the money should be devoted to quickly tackle social shocks, with a fast track to identify and support the most vulnerable among households and enterprises.

Valerio Alfonso Bruno

… equity provision is delicate … ”

I would distinguish between support to households and firms. For the former the help – for instance through stronger unemployment benefits or financial compensation for reduced working time as in Switzerland – should be provided with no requirement on payback. For the latter, the idea is to support firms that faced a temporary drop in income, but are otherwise viable, without subsidizing firms that are fine anyway. The baseline option should be for loans to be paid back, with low interest rates and long maturities, with the option of a write-off of government backed debt for firms that cannot fully pay back even though they are sound looking forward. This backup option should be administered while keeping administrative complexity to a minimum. Equity provision is delicate, as quoted firms are usually the large ones which are less constrained than the smaller ones.

Cédric Tille

… recapitalization, or even partial nationalization, seem necessary …”

Recent experiences in the USA (checks for no consideration have been granted to the needy population): 2/3 of the sums allocated were not spent! For investments: in addition to the available money, necessary performance prospects are needed! In one word, economic visibility – and the stability of the legal environment – must be restored. Meanwhile, medium-term government-guaranteed loans, possibly refinanced by the central bank. For the most important industries because of their economic environment – in Europe the automobile – recapitalization, or even partial nationalization, seem necessary.

Etienne Perrot

… the basic rule is to share risks and benefits fairly …”

Let us concentrate here on financing enterprise. The pandemic is bringing lasting changes. Finance should concentrate on the enterprising enterprises which intend to meet the needs of the future, including new firms. The basic rule is to share risks and benefits fairly. Fixed interest loans will only do that by the remotest of chance. Acquiring equity is fairer, but since it means getting involved in the affairs of the enterprise, it only suits large firms. Small ones are better served by indulgent creditors willing to accept the prospect of uncertain returns and repayments.
By Edouard Dommen on a related topic: http://www.chretiensdegaucheromands.ch/wp-content/uploads/2020/06/Dommen-apre%CC%80s-pande%CC%81mie.pdf

Edouard Dommen