• Thoughts on the Market

Recovering from the Stimulus

With Chetan Ahya and Andrew Sheets

How can we best coordinate policy to support a timely recovery from the impact of COVID-19 and what lessons can we learn from past crises?

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Current Episode Transcript

Chetan Ahya: Welcome to Thoughts on the Market. I'm Chetan Ahya, Chief Economist for Morgan Stanley.

Andrew Sheets: And I'm Andrew Sheets, Chief Cross-Asset Strategist at Morgan Stanley. And on this special two-part edition of Thoughts on the Market, we'll be talking about the impact of the coronavirus pandemic on the global economy and the effect on markets longer term. It's Thursday, May 7th at 11:00 a.m. Eastern Time.

Sheets: Chetan, we're now several months into this pandemic and we've seen governments around the world meet the challenge with what you've called a "full court policy" press to support economic activity. Maybe it's self-evident, but why do you think the market cares so much about the aggregate level of debt, especially when borrowing costs are so low? They're some of the lowest we've ever seen in history. And then also around the deflation issue, you know, why do you think markets are worried about lower prices or falling prices when again, I think some actors could see that is not that big of a problem at all?

Ahya: Historically we've had the problem of high inflation. So whenever we have had high deficits, you've seen higher inflation. However, you know, the experience that we have seen over the last few years in the U.S. and developed world. I am of the view that we have to be actually concerned about the disinflationary pressures and not the inflationary pressures. So the hawks that you hear are really talking about this being an issue because they are coming in from the point of view that inflation is an issue. However, we think the real issue is disinflationary pressure. So we are watching more policy action to be taken up to support aggregate demand and prevent us getting into a deeper disinflationary scenario.

Sheets: So in some sense, you think people are almost skipping ahead a little bit too far, that they're too focused on what the impacts might be much further down the line and where the bigger question should be, how do we support the economy right now? How do policymakers make sure that the current recession is addressed as aggressively and as thoroughly as possible? Is that is that a fair way to think about it?

Ahya: That's right. Because what we have learned, that unless and until you have addressed the disinflation problem or deflation problem, you're not going to be able to handle your debt to GDP

Sheets: You know, I think that's really a fascinating point because if I think back to some of the issues that Europe had in 2011, 2012, I think exactly to your point, you can kind of reach these goals that almost become rapidly difficult to obtain, that the market demands that a country cut its debt, that forces the country to cut its spending, which causes the economy to weaken. And then those debt numbers get even worse, which causes those same actors to demand it do more. So, I mean, if you think back to both maybe the sovereign debt crisis and the aftermath of the Great Recession, Chetan, what do you think were the lessons of that and what do you think are the lessons that policymakers have taken from those two experiences? 

Ahya: Two key important lessons, I think first is in terms of timing of policy action. It needs to be immediate and quick. And second, we need to see coordinated monetary and fiscal policy easing.

Ahya: And in that context, a lot of times investors say that Japan did take up aggressive monetary and fiscal easing. And yet it did not get inflation back to normal levels. But look, I would point out to the fact that Japan never really implemented coordinated fiscal and monetary easing, i.e. did not take up both the policy easing together. So the lesson is that we need to act qu ickly and we need to act in a coordinated manner, in an aggressive manner on both fiscal and monetary policy front..

Sheets: That's actually a really great point you raise about Japan, because I think it is held up as this example of almost excessive government debt. It has one of the highest debt to GDP ratios of any developed country. And yet, as you're saying, it's actually maybe a little bit the other way around that Japan's problem has been that over the last 20 or 30 years, it actually hasn't acted aggressively enough on the easing side to help its economy achieve sufficient acceleration. And that that's ironically made the debt situation even worse.

Ahya: Yeah, absolutely. I mean, appreciate the point that we are not going to be able to literally pay back the debt right. At a national level, the way we address the debt problem is we have nominal income growth, which is made up of inflation plus real GDP. That needs to grow at a faster pace than debt. And it's very important to get inflation rate at a normal level from two perspectives. You want the corporate sector to come forward and do the investment. And second is that you want to manage your debt to GDP by way of higher GDP growth rather than trying to cut deficit and debt levels.

Sheets: You know, if you think about different economies around the world, this is a crisis, a public health crisis that's really affected every part of the world, every economy from countries large to small. But how are you seeing different countries address it? How do you think that different countries will deal with these different kind of fiscal and deficit pressures? And especially do you see any big differences between how the developed world and emerging markets try to deal with some of these challenges?

Ahya: Yeah. Andrew, I'll answer this question in two timeframes: the near-term and the medium term. So in the near-term, what we are seeing is that the developed economies are able to handle this shock much better because they have the policy space to actually take up aggressive monetary and fiscal easing to take care of their growth conditions. But in emerging world, they don't have much policy space, and hence, these economies will unfortunately have to take a bigger pain on the downside in terms of their growth levels.

Ahya: But in the medium term, those countries in emerging world will be in a better place because they have underlying higher structural growth rates and that will help them to manage their debt to GDP and get out of the debt problem faster. Whereas the developed world will take much longer to get out of this debt problem because their underlying structural growth rates are much lower.

Sheets: When we think about government spending, there is a lot of different forms that it can take. And so I'd also like your thoughts on, as investors observe various packages that have been announced and potentially feature packages to come, what types of measures do you think are generally most supportive of growth over the short term, in the longer term? And what type of measures do you think might be a little bit less effective given the nature of the current crisis?

Ahya: Andrew, again, I'll answer this question in two time frames. So in the near-term, we have seen that the corporate sector as well as the household sector have suffered income loss. So the most immediate response they would be looking for from the government is some kind of transfers which will protect the hole in the output and incomes that they have suffered from. But in the medium term, the policy mix will have to shift towards spending on health care, infrastructure, and education because those will be the investments which will help lift potential growth and the long-term growth outlook. If they continue with transfers, even in the medium term, that unfortunately will be suboptimal use of the policy space and will probably bring up the problem of lower productivity growth and inflation later on. So, in the near-term, transfers are good, but in the medium term it should be infrastructure, education, and healthcare.

Sheets: Thanks for listening. We'll be back in your feed soon with part two of my conversation with Chetan Ahya, Chief Global Economist for Morgan Stanley. 

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