The St Andrews Economic Policy Research Group has been working on a series of extended reports this year. The second report concerns recession remediation.
By Nevin Benoy, Junghoon Kim, Donghyun Kim & Temmuz Ozcagatay
Our research project involved investigating four policies used in response to the Great Recession (’08 to ’09) to ascertain whether they were viable to aid the recovery from the recession caused by the Covid-19 pandemic (’20). The four policies investigated were Quantitative Easing, Base Rate manipulation, fiscal stimulus measures and the use of Automatic Stabilisers.
Firstly, our research found that whilst Quantitative Easing was a crucial part of the response to the Great Recession, its short-term efficacy and the lack of a similar financial crisis in the current economic picture suggests that it would be a viable but less effective policy for the current recovery.
Secondly, reducing the base rate much further would leave the UK following the negative interest rate policies pursued in Japan and across Europe. In theory, there is concern that such a policy would be contractionary as it could harm the health of British commercial banks as they struggle to pass on negative rates to deposits through fear of mass withdrawals. In turn, their profits and thus ability to lend declines. Yet, based on evidence from the Eurozone and beyond, we have found that in practise negative rates can function as a conventional reduction in the base rate, stimulating the economy. Moreover, there is evidence of negative rates providing a novel corporate channel of stimulus through the incentivisation of spending in high-liquidity firms. Thus, we have concluded that negative rates of a few tenths of a percentage point is a viable option to aid the recovery.
Furthermore, we found that fiscal stimulus measures used after the Great Recession would also be viable. However, with concerns about the rising national debt, we found that the government would be better off utilising the ‘stored stimulus’ retained in household savings. Indeed, over the course of numerous national and regional lockdowns, households have accumulated billions in savings, with these aggregate savings some five times larger than at any point in the last nine years. By targeting these households and incentivising the spending of this cash, the government could enact the same effects of fiscal stimulus without the need for extensive borrowing.
Finally, the viability of automatic stabilisers, like unemployment benefits, assisting the recovery depends on the rate of unemployment. Whilst unemployment has been suppressed through extensive use of the Furlough scheme, we found through independent modelling that unemployment is likely to substantially increase through the next few years. Thus, measures similar to those used during the Great Recession will provide stimulus and aid the recovery if and when unemployment rises.
Ultimately, a successful vaccination rollout is undoubtedly the best policy to remediate the recession as it facilitates the end of repeated lockdowns and reduces consumer and business health concerns, which stifle economic activity. That being said, our investigation has concluded that the four policy areas investigated would all be viable to aid the recovery as they did during the Great Recession, with important caveats. Read the full report on our website.