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The Coronavirus Aid, Relief, and Economic Security (Cares) Act that provides sizable support to the economy in the amount of roughly $2 trillion, or 9.2% of GDP, is expected to be passed by Congress and signed into law. The majority of the increase in deficit spending is for income support to lower- and middle-income households and individuals directly affected by the coronavirus pandemic, and an array of businesses, particularly small businesses that will face a financial squeeze.
This fiscal package is more than double the size of the American Recovery and Reinvestment Act of 2009 (ARRA), enacted in response to the 2008-2009 financial crisis. Combined with the very aggressive initiatives undertaken by the Federal Reserve, the macroeconomic policy responses to the crisis are unprecedented and quick.
Will they be enough? The Fed’s initiatives—unlimited Large-Scale Asset Purchases (LSAPs or QE), including purchases of MBS and corporate bonds plus unlimited infusion of liquidity into financial markets, should be sufficient to restore “normal function” of financial markets. But as we have emphasized, this crisis is a real one that cannot be fixed by monetary policy (Fed takes extensive and unprecedented actions, March 23, 2020).
Regarding fiscal policy, the answer depends on a number of factors. The income support provided by this legislation will replace some of the income lost during the acute stage of the crisis, but certainly not all of it, and its subsidies to small businesses will tide over many businesses, but many will fail unless product demand recovers and resumes growing.
If the acute stage of this epidemic ends relatively soon—and early indications suggest that is happening in China and other Asian nations including South Korea and Taiwan—then the magnitude of the fiscal package will be sufficient.
Our downside-risk scenario is not deeper contraction in the near term, but rather an elongated acute stage that has mounting negative impacts on work and production.
Two other issues will play important roles. First, how these fiscal initiatives are implemented is very important. An efficient disbursement of financial supports to small businesses through the Small Business Administration (SBA) and the commercial banking system is important for allowing those businesses to remain afloat and retain employees. The distribution of the government subsidies into the healthcare system is equally important in providing necessary medical services and hiring sufficient staff to facilitate those services. The well-documented wasteful track record of spending on “shovel-ready” infrastructure projects in implementing the ARRA highlights that the total amount of the legislated authorized spending may be a misleading measure of the effectiveness of the fiscal support. At this writing, few details are available on the fiscal legislation and how it will be implemented.
Second, directives of government officials on all levels of government are very important, and as influential in determining economic outcomes as is the fiscal legislation. Blanket shutdowns, however well-intentioned, reduce employment and output. Simply saying there is a direct tradeoff between economic activity and health safety (flattening the curve) is naïve and incorrect. Recognizing this, Governors Cuomo of New York and Newsom of California have issued directives that provide a long list of “essential businesses” that should remain open. As we rapidly gain scientific knowledge about the nuances of the spreading of the coronavirus and how to constrain it and better protect the at-risk population, more workers can begin working productively. This will lift economic activity and ease fiscal burdens.
Our current baseline assessment is that following the very deep contraction, with double-digit declines in consumption, production and capital spending, and millions of job losses, a moderate recovery will begin to form toward the end of the second quarter, with a recovery that lifts output and employment, but back to levels that are below their pre-crisis levels.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act
The White House and Congress have agreed on fiscal legislation, the Coronavirus Aid, Relief, and Economic Security (CARES) Act, that provides economic relief to individuals, small businesses, and corporations affected by the coronavirus (COVID-19). In addition to subsidies for select businesses like airlines, the legislation also increases funding for hospitals and state and local governments to support efforts to diagnose and treat patients, increase the supply of vital medical equipment and supplies, and to contain the spread of the virus.
The CARES Act is a historic, massive fiscal legislation that is estimated to cost roughly $2 trillion (above 9% of GDP). The White House and Congress fully recognize the importance of quick action as they already enacted two pieces of legislation, costing $8 billion and $100 billion, aimed at treating and preventing the spread of COVID-19, expanding paid sick leave, boosting unemployment insurance, and increasing federal Medicaid funding. Following the enactment of the CARES Act, there will be pressure from state and local government officials for the Federal government to provide additional funding.
At this writing, the text of the legislation has not been released to the public, and the Congressional Budget Office has not provided its official cost estimates of the legislation. As such, our assessments are high level and incomplete.
Income support
The CARES Act aims to mitigate the costs of the economic contraction and job losses by providing direct income support to households and by significantly enhancing and expanding unemployment insurance. As we have previously noted, many of the job losses will occur in service-providing sectors, particularly leisure & hospitality, as well as retail trade and nonessential business operations (US employment to plummet – temporarily, we hope, March 20, 2020).
The bill sends direct payments of $1,200 to individuals, $2,400 to married couples, and $500 for each child under the age of 17. The payments phase out for individuals and couples with adjusted gross incomes of more than $75k and $150k, with no payments going to individuals and couples earning more than $99k and $198k, respectively. Households that did not file tax returns for 2018 or 2019 are not eligible for this payment. These cash payments will likely be distributed in several weeks.
The CARES Act boosts unemployment insurance (UI). Under current law, individuals may receive UI for up to 26 weeks. The CARES Act extends coverage by an additional 13 weeks to 39 weeks, and provides an additional $600 per week for four months of coverage. Importantly, it expands unemployment benefits to cover nontraditional, so-called “GIG workers”, who are legally independent contractors rather than employees of firms. The Bureau of Labor Statistics estimates that roughly 6 million people hold contingent jobs and 11 million work as independent contractors.
Fiscal aid to businesses
The legislation provides loans and grants to businesses to help them maintain operations and payrolls, and also provides tax credits and other benefits to companies that retain employees. The fiscal subsidies will go to many small businesses as well as specific industries and larger companies that have been crippled by the crisis. The legislation aims to minimize job losses and reduce labor market dislocations stemming from the sharp contraction in product demand and cash flows facing many businesses.
The CARES Act creates loan funds of $425 billion for badly affected industries, cities, and states; $50 billion for passenger airlines; $8 billion for cargo airlines; and $17 billion for firms that are deemed important to national security.
The legislation provides significant support to small businesses (<500 employees), which account for almost 50% of private nonfarm employment in the U.S. It creates a $367 billion loan program to assist them with maintaining payrolls, $17 billion of which will be used for six-month loan forbearance on existing Small Business Administration (SBA) loans. Each small business can receive a maximum loan of $10 million. If the business maintains its payrolls, the portion of the loan used to cover payrolls, mortgage interest, rent, and utilities would be forgiven, retroactive to February 15, 2020. Under this initiative, the SBA will be able to make total loans in a magnitude much larger than the $367 billion program, because in the budget authorization legislation, that amount is the estimated loss of the credit provision.
The CARES Act also includes an employee retention tax credit that provides an estimated $50 billion to firms that retain employees. Under this provision, businesses must maintain 50% of employees’ paychecks. The bill provides tax relief for businesses in the near term by allowing them to defer payment of their 2020 payroll taxes until 2021 and 2022.
Firms receiving government loans are banned from doing stock buybacks for the term of the government assistance plus one year.
Healthcare and other provisions
The bill provides $150 billion for state and local government funding and provides $130 billion for hospitals and health care providers. These provisions are aimed to provide financial support to state and local governments and private health providers so they may increase hospital capacity, obtain necessary medical equipment and staffing, and finance other obligations as COVID-19 spreads.
The bill provides $30 billion in emergency education funding, $25 billion in transit funding, and $30 billion for the Disaster Relief Fund.
The Fed’s monetary responses
The Fed has taken unprecedented steps to address the pandemic crisis and prevent it from becoming a financial crisis. In addition to reducing its policy rate to 0-0.25%, it has initiated open-ended, massive QE, including purchases of investment-grade corporate debt on the secondary market, increased temporary repo operations, and a number of other programs that infuse large amounts of liquidity into an array of financial sectors, and otherwise provide support to ongoing credit.
These initiatives by the Fed are significantly more aggressive than its responses to the 2008-2009 financial crisis.The Fed has clearly learned from that period; its actions are aggressive and not tentative. We expect these actions will help financial markets to operate as efficiently as possible during the acute stage of this current crisis. However, we emphasize that the Fed’s initiatives do not and cannot contribute to fixing the health crisis and can only partially mitigate the negative economic fallout from the various mandated government shutdowns.
We fully acknowledge that financial support to the corporate bond market and municipalities are best and most appropriately provided by the Treasury and fiscal authorities. In this crisis environment, the Fed is encouraged to acknowledge appropriate boundaries between monetary and fiscal policies and set forth strategies for exiting these emergency policies at an appropriate time.
Mickey Levy, mickey.levy@berenberg-us.com
Roiana Reid, roiana.reid@berenberg-us.com
Sources:
https://www.cnn.com/2020/03/25/politics/stimulus-senate-action-coronavirus/index.html
https://www.politico.com/news/2020/03/24/congress-coronavirus-emergency-package-146066
https://www.latimes.com/politics/story/2020-03-24/congress-white-house-stimulus-deal-coronavirus
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