Paying the Covid Bill

The death and disruption were bound to create real economic losses, even if things are better now than what one might have feared in the spring of 2020. Modest inflation is the least worst outcome.

It would have been weird if a global pandemic that’s shut down large swathes of business activity and has killed more than ten million people worldwide had no economic or financial cost. Yet in most rich countries, consumers are richer than before, workers’ wages are higher, and businesses are flush with cash. If most people had known—at the end of 2019—what the body count was going to be and what the current state of the economy would be, they would be amazed at how well things had turned out.

That’s not because the coronavirus has been beneficial, but because policy choices shifted the economic and financial costs of the pandemic elsewhere. Many governments, particularly the U.S., managed to distribute the losses of the pandemic in ways that have made most people better off. The costs aren’t gone, and the bill will eventually be paid through some combination of low interest rates and inflation. (And, if we’re lucky, higher productivity.) This is the necessary context for evaluating current concerns about delivery delays and price spikes.

The alternative was a massive depression

Some people seem to forget now, but the situation last spring was incredibly dire. When the pandemic first emerged in Wuhan, China’s Hubei province experienced an unmitigated economic collapse, with industrial output down by half and homebuilding down by 70%.1

Seeing that, in March 2020 I wrote that:

We should temporarily break the link between income earned and output produced by having the government pay for all the transactions we would have done had there been no virus…Consumption and production would still fall as most people stay home, but money would continue to flow…The goal should be preventing the inevitable decline in consumption from reducing incomes in affected sectors, which would lead to further cuts in spending and a downward spiral hitting the rest of the economy.

Nobody followed this advice precisely.2 But many governments nevertheless spent trillions of dollars to prevent incomes from falling even as production tumbled.

According to the the International Monetary Fund’s latest Fiscal Monitor, the world’s governments spent about $10.8 trillion in “above the line” measures, with $5.5 trillion coming from outside the U.S. In addition, governments—almost exclusively in continental Europe and Japan—also took on about $6 trillion in “contingent liabilities” by guaranteeing the obligations of private borrowers and through “quasi-fiscal operations.”

The combined fiscal firepower of the world’s governments was worth about a sixth of global GDP. In the rich countries, it was more like 30-40%. That ensured a mismatch between real economic activity and nominal incomes. If it hadn’t happened, the economic consequences of the pandemic would likely have been worse than the Great Depression.3

In the U.S., the government disbursed so much that the disposable income received by households and nonprofits from March 2020 through August 2021 was 11% higher than in the 18 months ended February 2020. Similarly, nonfinancial corporations generated 7% more in after-tax profits from 2020Q1 through 2021Q2 than in 2018Q3-2019Q4.

That was extreme, but it wasn’t unique.

In the euro area, disposable household income was 2% higher in 2020Q1-2021Q2 than in the previous 6 quarters, while corporate profits were essentially flat. In Japan, household disposable income was 3% higher in 2020Q1-2021Q2 than in 2018Q3-2019Q4 on a seasonally-adjusted basis, although corporate profits fell. In the U.K., household disposable income was up by 2% while corporate profits were up by 7%.

These mismatches between private sector incomes and actual production were always going to have consequences

At first, the effect was a surge in public debt that was almost entirely financed by a surge in private saving. Even as governent debt ballooned, the ratio of total U.S. debt to national income as of 2021Q2 (354%) was still lower than it was in 2008-2009. Cash, bank deposits, and money-market fund shares held by American households and nonfinancial businesses rose by 29%, or more than $5 trillion.


The growth in holdings of deposits and other money-like assets by households and nonfinancial businesses in the rest of the rich world wasn’t quite as dramatic, but it was still massive. Compared to the end of 2019, liquid assets held by the nonfinancial private sector jumped by €1.6 trillion in the euro area (14%), by ¥116 trillion in Japan (9%), and by nearly £500 billion in the U.K. (19%). At current exchange rates, that’s about $3.5 trillion in extra cash.

Once rich world governments started handing money to the private sector in these volumes, the big question was what would happen next.

At one extreme: nothing. Here’s how I described the downside risk in mid-April 2020:

Businesses that had been optimized for a world without pandemic risk will likely adapt in ways that make them more resilient during crises but less efficient the rest of the time…If U.S. companies emulate the way Japanese companies manage operations, expect corporate cash hoarding at the expense capital investment.

Households, too, can be expected to change behavior in the post-pandemic world…many people will choose to consume less overall in an attempt to build up a buffer of emergency savings. The financial crisis pushed the average American’s savings rate up from about 4% from 2000-06 to about 7.5% since 2012, and the increase looks even larger after accounting for changes in the level of interest rates and the ratio of wealth to income.

Less spending by American consumers will push American businesses to produce less, which means lower income and employment across the economy unless spending by the government and the rest of the world somehow picks up the slack.

The downside scenario was that all of the extra cash would remain stuck in bank accounts, financing nothing but lenders’ own holdings of central bank reserves or government debts, which in turn had been created only to satisfy consumers’ and businesses’ newfound desire to save. It would have been a re-run of the world after the global financial crisis on a far larger scale: lots of additional money mostly doing nothing. Thankfully, this doesn’t seem to have happened.

The other extreme option was that the trillions of extra cash would get spent immediately on whatever goods and services were available to buy. That would be better for growth than the alternative, but it would also probably translate into price spikes for certain items. Here’s how I framed it in early May 2020:

The best reason why it might be worth betting on inflation is that faster price increases would help the economy recover more quickly after the virus is defeated. By limiting our ability to spend, the virus is forcing consumers to save…If consumers are permanently scarred by this crisis and keep their savings rate elevated, we will suffer slower growth for many years to come. We should therefore hope today’s savings get spent as soon as possible.

Most of that extra spending would likely get absorbed by the excess capacity currently plaguing the economy. Some of it wouldn’t, however, which would lead to a bump in prices of the sort we experienced after the end of rationing following World War II…More generally, reallocating labor and capital from sectors such as casinos and cruise lines to medical manufacturing and grocery delivery will likely be necessary, but it will also lead to reductions in productivity as workers learn new skills and businesses write down old investments. Broadly rising price and wage inflation will smooth the adjustment process.

So far, this isn’t quite what’s happened either.

For one thing, most of the money has been saved—which is also consistent with the post-WWII experience. American consumers spent far less than their underlying incomes from the start of the pandemic until this spring.4 Even as household spending has started to rise faster than underlying incomes, the difference hasn’t been very big—and it’s still smaller than the value of government aid coming in each month. The stockpile of cash should help prevent a sudden drop in spending as government income support recedes.


At the same time, the rapid deployment of extremely effective vaccines—something that I and most other people weren’t expecting last spring—has reduced the need to fundamentally reshape the composition of economic activity. It turns out that we don’t need a lot more hand sanitizer, face masks, or grocery delivery than in the past, while casinos and cruise lines will probably come out of the pandemic just fine.5

So far, at least, we are comfortably between the two extremes of permanent depression and inflationary boom.

But there has been a persistent increase in consumer spending on goods relative to services

For a brief moment during the spring of 2021, inflation-adjusted U.S. household spending on durable goods such as cars, televisions, computers, appliances, furniture, and exercise equipment managed to return to the long-term 1959-2006 trend—after more than a decade of being roughly 20% below that trend.

While demand has tailed off a bit since then, as of August 2021, total real purchases of consumer goods (durable and nondurable) were still 15% higher than in February 2020 on a seasonally-adjusted basis. It’s helped compensate for the fact that inflation-adjusted spending on consumer services was still 2% lower. The shift has broken an extremely long downward trend in the share of household spending on goodsand has put pressure on the manufacturing and logistics businesses that satisfy our desires for physical objects.

The same basic pattern can be seen in other rich countries, although the overall numbers look worse because consumers there were given less income support than in the U.S. In Japan, total household spending fell—but spending on goods fell much less than spending on services.

Among the major European economies for which we have data (the median of Austria, Denmark, France, Germany, Italy, and the Netherlands), real spending on durable goods was about 4% higher in 2021Q2 than in 2019Q4, while real spending on services was 12% lower. In euro terms, the weighted share of household spending on services fell from 54% of the total before the pandemic to 50% as of 2021Q2.

Much of the heightened demand for goods has been met by higher global production. But certain producers’ skepticism of the rebound in 2020 held back output, forcing retailers to run down their inventories as consumers endured delivery delays and, sometimes, higher prices. That’s only continued in 2021.

But what would the alternative have been? Not supporting incomes during a global pandemic if you have the option?

The shift from services to goods was logical and necessary. Without it, we either would have had a much bigger drop in total consumption—and therefore incomes—or we would have had a much bigger health problem from crowding more people into unsafe environments.

And it’s not as if the current level of goods demand is inherently unreasonable. As the economist Josh Mason put it recently, the claim that we’re now buying too much “is implicitly saying that we cannot and should not try to ever reverse the damage from the Great Recession.” Regular readers of The Overshoot know what I think of that.

The pandemic itself was the problem. We could have handled it better, but the things governments did—especially in the U.S.—were helpful precisely because they spread out and redistributed the financial impact of the economic shock. Instead of mass foreclosures and business bankruptcies that would have crippled the private sector for a generation, governments absorbed the hit to net worth by taking on trillions of dollars of new debt.

Instead of enduring outright losses, investors made money on stocks, bonds, and real estate. But now they face the prospect of lower inflation-adjusted returns than in the past. And while consumers were forced to cut back on everything from trips to the dentist to a night at the movies, we were at least able to console ourselves by buying everything from fancier cuts of meat to home gyms, not to mention finally renovating our kitchens.

If the biggest complaint we can muster now is that we have to wait a few extra months for a new couch, or that it costs more than we’d like to buy a new car, or that “it’s so hard to find good help these days,” my answer is: that’s what success looks like.


We later learned that economic activity fell about 30% between February 2020 and April 2020 (on a seasonally-adjusted basis) across the U.S. and Europe.


Following Emmanuel Saez and Gabriel Zucman, I was concerned about the longer-term economic and social damage that might follow if we failed to preserve existing businesses and employer-employee relationships, which is why I thought the best policy would be having governments guarantee that every business would hit whatever 2020 and 2021 sales numbers might have reasonably been expected in 2019.

Instead, European countries, Japan, and Canada opted to subsidize employers up to a certain amount if they kept workers on staff instead of laying them off. The U.S. went in a totally different direction, providing trillions of dollars of aid directly to consumers through “economic impact payments” and massive enhancements to unemployment insurance benefits. The U.S. approach was more hamfisted but also much more generous, especially because the initial package from the spring of 2020 was re-upped with additional spending bills throughout the year and into 2021.


The public health consequences would also have been worse as desperate people would have been more willing to risk their safety and the safety of others to earn whatever was necessary to survive.


In the rest of the world, consumers got less support and consumption has been correspondingly weaker.


Faster baseline inflation might facilitate the transition to a green economy, but that’s a different question.