The Economic Risks of Pandexit by Howard Davies


While everyone is hoping that Pandexit, or the end of the COVID-19 pandemic, will come soon, the economic benefits will not be without mixture. A plausible pessimistic scenario is that current price pressures intensify and inflation increases further, ultimately requiring a monetary response.

EDINBURGH – People have been using ‘exit’ as a suffix for about ten years. Grexit, referring to Greece’s potential exit from the eurozone, was the first to emerge. Italexit made a cameo appearance, and was recently relaunched on the Italian right. But neither has happened. Neither does Frexit, or the unilateral withdrawal of France from the European Union. Far-right politician Marine Le Pen has flirted with the idea before, but then dropped it. And the only candidate in the 2017 French presidential election to have advocated it, François Asselineau, only obtained 0.9% of the vote.

Such outings seem to put off most continental Europeans. So far, only Brexit has actually taken place, although polls in the month leading up to the June 2016 referendum in the UK showed that more French voters than British voters were unhappy with the EU, by a margin of 61 % to 48%.

All of these potential and actual exits were viewed by most economists as undesirable. Now another one is under discussion that everyone is hoping for: Pandexit. This unsightly coat rack sums up the optimistic idea that we can soon hope to put the COVID-19 pandemic behind us, and start kissing casual acquaintances (on the cheek at least) again and sinking like sardines into streetcars and trains in cities from New York to Tokyo.

There is little doubt that in economic terms the first order consequences of a return to normal social interactions will be positive. Researchers at the Bank for International Settlements (BIS) estimate that the pandemic caused an 8% production loss in developed countries in 2020 and forecast a further decline of just over 2% this year. The easing of travel and other restrictions is expected to allow a strong recovery in 2022, although its magnitude varies widely from country to country depending on infection and vaccination rates. And, of course, a general upsurge in infections or re-infections could produce a third wave of economic hardship if further activity restrictions were required.

In addition, not all of the economic benefits of Pandexit will be fully combined. Central bankers, who know how to turn opportunities into problems, are already worried. Although their basic economic scenario is positive, they see significant risks. “Policymakers still face daunting challenges,” BRI Director General Agustín Carstens recently said. “Public and private debt is very high and the consequences of the pandemic are significant. ”

Carstens’ key point is that the economic damage created by COVID-19 has been mitigated by an “unprecedented macroeconomic policy accommodation”: very low interest rates and massive doses of quantitative easing, as well as a “ample” budget support. The degree of budget support has varied from country to country and is much greater in the United States than in Europe, for example. But public debt has risen sharply everywhere and is now reaching unprecedented levels in countries like Italy and Japan.

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Against this background, the BIS has identified two dangerous bearish scenarios. The first is essentially epidemiological: new variants of the coronavirus may emerge, requiring additional lockdowns and fiscal support, which could be infeasible for some governments. But in my opinion, further blockages will prove to be politically impossible. So if new viral mutations spread quickly, we’ll have to fend for ourselves as best we can and hope that the vaccinations will minimize additional deaths.

The second bearish scenario, which I consider much more plausible, is that current price pressures intensify and inflation increases further, possibly requiring a monetary response. Consumer price inflation in the United States was 5.4% in July. The Baltic Dry Index, which tracks shipping rates for dry goods, has increased by around 170% this year. And supply constraints appear in many regions.

The official line of the US Federal Reserve and other central banks is that this inflationary surge is transitory. But as the French saying goes, “nothing lasts like the provisional” (nothing lasts like the temporary). If the current central bank consensus is wrong, as former US Treasury Secretary Larry Summers and others believe, problems could arise.

The monetary tightening during Pandexit will have more serious consequences than usual. Since central banks have sucked in so much public debt, the average maturity of government bonds has effectively shortened, so that public sector balance sheets are more sensitive than usual to changes in interest rates at short term. Governments will not be happy with the tightening of central banker policy in their countries, as this could have direct budgetary consequences.

In addition, monetary tightening in the developed world, particularly the United States, will be highly undesirable for emerging markets. Most still struggle to control the pandemic and have COVID-19 vaccination rates well below those in Europe or North America, despite recent encouraging signs that rich countries are now more willing to share their vaccine stocks.

In responding to the pandemic itself, we have all faced similar challenges, and the mix of policies used by governments has been broadly the same. During the Pandexit period, that could all change. Measures that might make sense for countries with low COVID-19 infection rates and manageable public debt could spell economic disaster for others.

Carstens thus calls for the normalization of monetary policy “to be very gradual”, although he also asserts, as one would expect, the primacy of the control of inflation and the independence of the central bank. He might have added that we will need more coordination of international policies, which has barely been seen in the past year and a half. The BIS itself has a job to do.


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