Covid-19: Mapping the route to an inclusive economic recovery

The fact that central banks will need to continue providing significant assistance, drawing on a range of existing programmes, is an important part of the Covid-19 recovery framework. This should ensure financing costs remain close to zero and, just as importantly, that credit will continue to flow freely through the banking sector. Further interventions from government are also likely to be necessary, despite the prospect of public sector debt climbing more steeply still.

It is as yet unclear whether it will be sufficient for governments to simply build on measures undertaken so far. The path ahead is thorny, and difficult to navigate. The challenge to policymakers is not limited to managing the threat posed by a second wave of the Covid-19 virus. Of arguably greater significance will be the legacy of the pandemic on geopolitics – specifically, international support for multilateral institutions and coordinated global actions. Populist politics could well be further boosted as the blame game around the origins and spread of the virus intensifies.

In this environment, there is a very real risk that embattled governments will seek to implement a fresh raft of protectionist policies. Such measures would likely focus on trade in the first instance but, in due course, could also impede the free flow of capital. The popular appeal of superficially attractive measures supporting local industries and people has been increasingly evident over recent years. The encounters between the US and China, and, to a lesser extent, within Europe, are evidence of this. Yet it would be short-sighted not to recognise the costs associated with such an approach: this is, ultimately, a zero-sum game. Over time it will lead to slower global growth, cause living standards to stagnate and widen existing inequalities. These are the very conditions that underpinned the resurgence of protectionist politics in the first place.

In order to build a solid platform for an economic recovery that is both sustainable and inclusive, this challenge must not be shirked. I would suggest that the time has come for governments and central banks around the world to rethink the orientation of monetary policy. When inflation targeting became the norm for managing interest rates, it was against a very different macro backdrop. Indeed, central banks have consistently failed to hit inflation targets over the last decade – and in some cases for rather longer. This, effectively, has rendered the policy tool redundant. More importantly, it has also undermined the credibility of central banks, raising question marks about their function in contemporary society.

A number of alternatives to an inflation target have been raised in the past and I don’t intend to conduct an exhaustive analysis of the merits to each. That said, I would probably opt for a simple nominal GDP growth target. Just to be clear, this would capture the total money value of economic output incorporating not just inflation, but also the activity or ‘real’ component. So, typically, central banks with an inflation target of 2% may be asked to build in an expansion in the economy of a further 2%, so making a goal of 4% growth. Of course, in the current circumstances the objective provided by policymakers could be significantly higher to make up for lost ground – perhaps 10% or more.

Just because there is a target in place does not mean it can be achieved – as we have seen with the inflation goal. However, such a target would provide a useful anchor around which to focus decisions. Targets are also effective as a means of articulating a direction of travel, and can be clearly communicated to markets, businesses and households. Moreover, a target can help in more formally aligning monetary policy and fiscal frameworks. This would, in some ways, seem a natural progression – particularly given the latest expansion of quantitative easing across many parts of the globe. QE has effectively provided an underwriting mechanism for the huge increase in public borrowing sanctioned in order to counter the impact of the crisis.

This is, however, just one part of a strategy to ensure that economic growth is achieved, and that it is genuinely inclusive. It could be argued that there has never been a better time to refocus on the need to upscale infrastructure spending across the world. Improved connectivity, healthcare and education will assist us in managing future pandemic events. Much has been said about the scale of the infrastructure gap; numbers are naturally important in explaining the magnitude of the financing requirement. In order to ensure public support for projects, it is critical that the benefits of investment are tangible and help facilitate genuine improvements.

High public borrowing and high public debt levels may be viewed by some as a less than ideal backdrop against which to initiate these sorts of programmes. But backtracking and reverting to any form of austerity will, in the near-term, be costly for the global economy. I also wonder if this is the time for governments, particularly those in the West, to rethink their role in economic activity. A legacy of outstanding loans to businesses initiated through various Covid-19 related support programmes could ultimately act as a drag on macro performance for some time to come. Could this be an opportunity to consider a conversion to equity, and the creation of what would effectively be viewed as Sovereign Wealth Funds?

This is a theme that I may return to in future articles.