The blog of the Urban Institute
March 17, 2020

The COVID-19 Recession Will Be Different

March 17, 2020

People across the world are making dramatic changes to their daily routines in response to the rapid spread of COVID-19. The coronavirus is transmitted easily, even before symptoms are apparent, which makes preventative action essential to contain the virus.

In response, schools and restaurants are closing and large events are being canceled to minimize opportunities for new infections. People are practicing “social distancing” to slow the spread and ensure hospitals are not overwhelmed with patients in critical condition.

The disruptions caused by this new reality have important economic consequences. Economists are in broad agreement that the US is likely to enter a recession, and on Sunday, the Federal Reserve took aggressive steps to bolster the economy.

What a COVID-19 recession looks like

Because of social distancing and widespread closures, a COVID-19 recession is likely to be different— and considerably worse—than typical postwar recessions. In a short research note on the issue, Gabriel Mathy, a macroeconomist at American University, argues that the COVID-19 recession will be the first “services recession,” driven to a large extent by depressed activity in the service sector associated with social distancing practices.

Recessions are normally characterized by a collapse of investment spending. Companies that are uncertain about future demand for their products try to put off equipment purchases. Fewer new homes are built as house values fall and homebuyers become uncertain about their financial future.

In contrast, consumer spending on services—like dining out, transportation services, or personal care services—typically fluctuate much less over the business cycle, acting as a source of economic stability. Mathy shows how during recessions, consumer spending on services actually tends to increase as a share of total spending.

In a COVID-19 recession, we may not have this normal source of economic stability as consumers practice social distancing and as service workers are laid off, get sick, or stay home from work. And services cannot generally be produced for future use; if I stay in my home and skip my usual haircut, that service cannot be produced now and stored in inventory for the future.

What are the policy solutions?

A “service sector recession” could cut much deeper than normal downturns. It may be less responsive to traditional policy remedies. The Federal Reserve’s decision to cut interest rates and buy billions of dollars of assets is targeted at reducing borrowing costs and increasing liquidity. This is usually done to encourage investment spending but likely won’t be much help in reviving the service sector.

Policies to support the service sector introduce thorny public health conundrums. Policymakers should work to prevent widespread economic hardship, but a revival of services could weaken efforts to slow the spread of COVID-19. As a result, none of the options look good.

Some legislators are suggesting that the federal government send checks to all Americans to provide for basic needs. Direct payments will ensure that low-income families have the resources to purchase basic necessities, but they are unlikely to revive the service sector as long as social distancing is in effect.

Arindrajit Dube, a labor economist at the University of Massachusetts, Amherst, suggests that policymakers focus on policies that incentivize employers to keep workers on the payroll even if production declines. Examples of these policies include an employment tax credit or ensuring that any mandate, such as a paid sick leave mandate, is federally reimbursable.

Policies that provide for basic needs and keep workers on the payroll limit the damage to families by putting the costs of that damage on the federal balance sheet. But these policies cannot generate the economic activity currently on hold to fight the spread of infection.

In this respect, this crisis is fundamentally different from prior recessions, and the government should be prepared to implement policies that foster strong economic growth after the threat to public health passes while ensuring that families and businesses are maintained through the crisis. COVID-19 calls for a balancing act between public health and macroeconomic stability that has no recent precedent, and policymakers need to be prepared.

Bill Rangal prepares breakfast for customers at Don's Grill in the Pilsen neighborhood on March 16, 2020 in Chicago, Illinois. Yesterday the governors of Illinois and Ohio announced they were closing bars and restaurants in their states in an attempt to curtail the spread of the coronavirus. Don's will remain open for carry-out orders only. The wait staff here and at many other restaurants are concerned about the affect this will have on their incomes since most rely on tips to make the majority of their income. (Photo by Scott Olson/Getty Images)

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