Research & Policy Briefs From the World Bank Malaysia Hub No. 28 March 26, 2020 Macroeconomic Policy in the Time of COVID-19: A Primer for Developing Countries Norman V. Loayza and Steven Pennings COVID-19 not only represents a worldwide public health emergency but has become an international economic crisis that could surpass the global financial crisis of 2008–09. Right now, containment and mitigation measures are necessary to limit the spread of the virus and save lives. However, they come at a cost, as shutdowns imply reducing economic activity. These human and economic costs are likely to be larger for developing countries, which generally have lower health care capacity, larger informal sectors, shallower financial markets, less fiscal space, and poorer governance. Policy makers will need to weigh carefully the effectiveness and socioeconomic consequences of containment and mitigation policies, responding to epidemiological evidence on how the virus spreads and trying to avoid unintended consequences. Economic policy in the short term should be focused on providing emergency relief to vulnerable populations and affected businesses. The short-term goal is not to stimulate the economy—which is impossible, given the supply-restricting containment measures, but rather to avoid mass layoffs and bankruptcies. In the medium term, macroeconomic policy should turn to recovery measures, which typically involve monetary and fiscal stimulus. However, in many developing countries, stimulus may be less effective because monetary transmission is weak and fiscal space and fiscal multipliers are often small. A more viable goal for macroeconomic policy in developing countries is avoiding procyclicality, ensuring the continuity of public services for the economy, and supporting the vulnerable. Because COVID-19 is truly a global shock, international coordination is essential, in economic policy, health care and science, and containment and mitigation efforts. Critical times call for well-designed government action and effective public service delivery—preserving, rather than ignoring, the practices for macroeconomic stability and proper governance that serve in good and bad times. A Public Health, Economic, and Humanitarian Crisis COVID-19 combines two fatal characteristics: it is three to thirty times deadlier than seasonal influenza, based on a crude case fatality rate, and The public health threat from COVID-19 is the most serious from a at least ten times more contagious than SARS (WHO 2020a; Wilson et al. respiratory infection since the 1918 Spanish flu pandemic (Ferguson et al. 2020; Wilder-Smith, Chiew, and Lee 2020). Its potential to wreak havoc 2020). COVID-19 is the fifth pandemic in the last 20 years and the ninth for public health around the world is enormous, in both developed and pandemic in the last century (World Economic Forum 2020). Although developing countries. At the time of writing, the COVID-19 crisis is only epidemics have been present throughout human history, the frequency just starting to come to low-income and lower-middle-income countries, of pandemics is rising (Fischer 2020). Better technology and greater with around 340 and 4,550 reported cases, respectively (as of March 25, resources mean that the world is in principle better able to fight disease. 2020). Cases are growing rapidly, increasing over tenfold in a week or two They also entail stronger interconnections among people, businesses, and (see figure 1). Fatalities are starting to rise, too. markets. With a new disease, for which humanity does not have immunity, interconnection implies the possibility of rapid and COVID-19 not only represents a worldwide public health emergency but has accelerating contagion. also become an international economic emergency that, in its negative effects, Figure 1. Cumulative number of cases of infection and deaths from COVID-19 by country income group 100,000 1,000,000 1,000,000 Cumulative number of cases of infection 10,000 100,000 100,000 Cumulative number of deaths 1,000 10,000 10,000 (log 10 scale) (log 10 scale) 1,000 100 1,000 100 10 100 10 1 10 24-Jan 26-Jan 28-Jan 30-Jan 1-Feb 3-Feb 31-Dec 5-Feb 7-Feb 9-Feb 10-Jan 18-Jan 20-Jan 11-Feb 13-Feb 15-Feb 17-Feb 19-Feb 21-Feb 23-Feb 12-Jan 14-Jan 22-Jan 25-Feb 16-Jan 2-Jan 4-Jan 6-Jan 8-Jan 1 1 1-Jan 1-Feb 1-Mar 1-Apr 1-Jan 1-Feb 1-Mar 1-Apr High Upper-Middle (excl. China and Iran) Lower-Middle Low China Iran Source: Authors' calculation using European Centre for Disease Prevention and Control (2020a) and World Health Organization (2020b) (via Our World in Data by University of Oxford, https://ourworldindata.org/coronavirus-source-data, accessed on 25 March 2020). Note: The cumulative number of cases of infection and deaths are in log 10 scale. The country income groups follow the World Bank classification based on annual gross national income (GNI) per capita: low-income, less than $1,025; lower-middle-income, between $1,025 and $3,995; upper-middle-income, between $3,995 and $12,375; and high-income, more than $12,375. Affiliation: Development Research Group, World Bank. Acknowledgement: Sharmila Devadas, Young Eun Kim, Nurlina Shaharuddin, Jorge Guzman, and Lay Lian Chuah provided extensive and important inputs. Aart Kraay, Aaditya Mattoo, William Maloney, Ayhan Kose, Firas Raad, Damien de Walque, Richard Record, Berk Özler, Guillermo Vuletin, Daniel Riera-Crichton, Sergio Schmukler, Rishabh Sinha, Roberto Fattal-Jaef, Stuti Khemani, Viktoria Hnatkovska, Mei Ling Tan, and Pierre Jean Bachas contributed with valuable comments and suggestions. Nancy Morrison provided excellent editorial assistance. Objective and disclaimer: Research & Policy Briefs synthesize existing research and data to shed light on a useful and interesting question for policy debate. Research & Policy Briefs carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions are entirely those of the authors. They do not necessarily represent the views of the World Bank Group, its Executive Directors, or the governments they represent. The COVID-19 pandemic and the policy response are evolving quickly. Some of the information presented in this brief at the time of writing (March 17–25, 2020) may be superseded. Macroeconomic Policy in the Time of COVID-19: A Primer for Developing Countries could surpass the global financial crisis of 2008–09. A global recession in The Costs and Benefits of (In)Action 2020 is not only possible but also very likely (IMF 2020a). Why? If no adequate public health actions are taken to contain the spread of the First, the engines of growth in the world economy—China, the United disease and alleviate its effects, the suffering and loss of human lives States, Europe—are and will be deeply affected. Goldman Sachs is could be catastrophic. The associated income losses could be forecasting a -9 percent contraction in China’s GDP growth in 2020:Q1 correspondingly large (Furman 2020). In addition, by slowing down and a -6 percent drop in US GDP growth in 2020:Q2, much worse than economic activity, containment and mitigation measures could the -2.2 percent growth recorded in 2008:Q4 (Bloomberg 2020; Goldman exacerbate the income losses associated with the pandemic. Sachs 2020). To assess the potential human loss from epidemics, public health Second, through contagion effects, these large economies will affect experts compare the number of people in critical need of medical the rest of the world. Evidence of this can be seen in the sharp drop of assistance with the health care system capacity to treat them at any point commodity prices since mid-February 2020, with oil prices falling to the after the onset of the epidemic (CDC 2012). While this capacity—in terms lowest level for 18 years, before recovering somewhat (The Economist of medical personnel, intensive care units (ICUs), hospital beds, 2020a; CNN 2020). ventilators, and so on—is relatively fixed (flat) in the near term, the number of people in critical need rises and falls according to an Third, most, if not all countries, around the world will be hit by the “epidemic curve.” The steepness, amplitude, and timing of this curve pandemic. This implies direct costs related to morbidity, health care, and depend on the effectiveness of containment and mitigation measures uncertainty. It also implies indirect costs related to containment and implemented to control the spread of the disease. mitigation measures, such as reduced labor, production capacity, and productivity. Figure 2 illustrates the epidemic curve under various containment and mitigation scenarios for the United States (Ferguson et al. 2020). Given Moreover, the pandemic, if not managed well, can produce a series of that COVID-19 is highly infectious and virulent, the potential for human other crises, including financial crises (if bankruptcies go rampant and loss is enormous (shown by the area below the black, orange, or green banks become illiquid or insolvent), sectoral collapses (for instance, in epidemic curves and above the red health care–capacity line in figure 2). airlines, tourism, and hospitality services), and macroeconomic crises (if In principle, containment and mitigation measures can “flatten” the the costs of mitigation turn out to be excessive given a country's fiscal epidemic curve: if they are timely and adequate and if they can count on space and income level)—with dire consequences for welfare and poverty people’s sustained support, these measures can spread over time the alleviation (World Bank 2013; Furman 2020; Odendahl and Springford number of people in critical need and lessen the intensity of the epidemic 2020; Galí 2020). Indeed, measures of market and policy uncertainty are (Gopinath 2020). Flattening the epidemic curve buys time to increase the higher now than at the peak of the global financial crisis (Ahir, Bloom, and capacity of the health care system (that is, to lift the red line in figure 2) Furceri 2020; Baker, Boom, and Davis 2020). and to develop an effective treatment and, eventually, a vaccine. What makes COVID-19 a different shock? First, it is a massive and In practice, however, mitigation and containment measures are hard highly contagious global shock. Second, it is simultaneously a negative to implement. In particular, strict containment or suppression measures supply shock and a negative demand shock: it reduces the ability of (such as lockdowns and movement restrictions) are not feasible for people to work and firms to produce, and it lowers the incentives and extended or repeated periods of time in overcrowded urban spaces, in possibility for people to consume and for firms to invest (Bénassy-Quéré communities where trust in government is lacking, in places where et al. 2020; Gopinath 2020; Furman 2020). Third, it may hurt low- and incomes are severely reduced, and for people who depend on outside middle-income countries disproportionately because they tend to lack work for subsistence. These conditions are especially prevalent in low- the resources and capacity to deal with shocks of this nature (World Bank and middle-income countries. 2013). The contribution of this Research & Policy Brief is to examine macroeconomic policy responses in the face of COVID-19 from the Not only are strict containment measures difficult to implement, but perspective, needs, and capacities of developing countries. they may not render lasting positive results. First, suppression measures Figure 2. The epidemic curve: Containment and mitigation strategy scenarios for the United States in the face of COVID-19 250 Surge critical care bed c apacity 200 Critical care beds occupied per 100,000 of population Do nothing 150 Case isolation, household quarantine and general social distancing 100 School and university closure, case isolation and general social distancing 50 0 Source: Figure reproduced from Ferguson et al. (2020) Note: The figure depicts three suppression strategy scenarios for the United States showing requirements for intensive care unit (ICU) beds. The black line shows the unmitigated epidemic. The green line shows a suppression strategy incorporating closure of schools and universities, case isolation, and population-wide social distancing, beginning in late March 2020. The orange line shows a containment strategy incorporating case isolation, household quarantine, and population-wide social distancing without widespread closures. The red line is the estimated surge ICU bed capacity in the United States. The blue shading shows the five-month period in which these interventions are assumed to remain in place. 2 Research & Policy Brief No.28 may result in a wave of infection after they are lifted, which may be worse indiscriminate travel restrictions across closely connected communities if they are not accompanied by more sustainable mitigation measures may be counterproductive because people will circumvent them such as extensive testing, contact tracing, targeted quarantines, and informally, making screening and detection harder (WHO 2015). public and personal hygiene. Indeed, the Spanish flu of Spring 1918 had For the economy, a shock as severe as COVID-19 implies a recession several later outbreaks in Fall 1918 and Winter 1918–19 (CDC 2018). (figure 3). High mortality and morbidity rates cause a decrease in labor, Second, without a vaccine—potentially 12 to 18 months or more away production capacity, and productivity (a supply shock). The associated (Ferguson et al. 2020), immunity to COVID-19 is acquired only naturally by increase in uncertainty and decline in wealth leads to a fall in the population catching the virus and then recovering. The more consumption and investment (a demand shock). The situation worsens draconian the suppression policies are in the near term, the fewer the under a global crisis because the negative supply and demand shocks are people who develop immunity are and the more vulnerable the transmitted across countries through trade, financial, and migration population remains to a new outbreak. (That’s why in figure 2, stronger linkages (Bofinger et al. 2020). suppression, represented by the green line, leads to a larger outbreak than milder measures, represented by the orange line.) While China and Moreover, attempts to flatten the epidemic curve come at a cost, as the Republic of Korea have had some success using extensive testing and the containment and mitigation measures specifically require a reduction contact tracing, there is a concern that a suppression-based strategy will in economic activity (see figure 3, red line) (Gourinchas 2020; require on-again, off-again lockdowns for the rest of 2020 (Ferguson et al. Eichenbaum, Rebelo, and Trabandt 2020). Social distancing slows down 2020). Not only might this not be feasible, it would also cause the spread of the disease but also forces most people to work less or less considerable social and economic disruption. productively; businesses depending on social gathering and physical presence (such as theaters, sports events, restaurants, commerce, While low- and middle-income countries have lower capacity to tourism, and hospitality services) to come to a halt; and labor-intensive implement strict containment measures, they do have one advantage: manufacturing plants to sharply curtail their production. Both supply and that is, their rate of infection appears to be currently low (figure 1), demand contractions combine as people work and consume less, while possibly stemming from low international connectedness. This creates a firms shrink their output and investment. In developing countries (and in short window for decisive action early on to slow down the virus before it vulnerable parts of developed countries), these economic losses have spreads uncontrollably. This can be done by creating awareness of tangible effects not only on average incomes but also on public services contagion, by disseminating information on good practices regarding (including health, education, and police protection), household personal and public hygiene, by testing and quarantining susceptible consumption, and eventually poverty and vulnerability (World Bank populations, and by screening of international travelers (WHO 2020c). For 2013). example, despite being heavily connected with China, Hong Kong SAR, China; the Republic of Korea; Singapore; and Taiwan, China acted early Sooner rather than later, policy makers will have to choose the right and contained cases, resulting in less dislocation, by implementing travel level and type of containment and mitigation measures, seeking to restrictions on visitors from China by early February 2020, carrying out balance the need to minimize the intensity of the health emergency with comprehensive tracking and testing, and instituting social distancing the objective of maintaining and reviving economic activity. They will have (New York Times 2020; The Wall Street Journal 2020a). to consider the epidemiological evidence on how the virus spreads and the evidence on the economic and social costs of containment and The experience of African countries fighting the Ebola virus epidemic mitigation measures. Draconian measures may have to give way to more is especially informative (Makoni 2020; Ebenso and Otu 2020). Successful targeted practices once the worst of the contagion phase is over. responses against the Ebola outbreak in Mali, Nigeria, and Senegal Containment and mitigation measures vary substantially in their cost. suggest the following priorities for public health care responses to Personal and public hygiene, extensive testing, and self-quarantine of COVID-19: procuring sufficient diagnostic testing kits; retaining and hiring susceptible groups (like the elderly) are less costly, while complete medical personnel and health workers to conduct testing and rigorous lockdowns, travel restrictions, and border closings are more costly (The and daily contact-tracing (for example, employing trained medical Economist 2020b; Panizza 2020). Strict containment or suppression students); obtaining protective equipment for medical personnel; measures might initially be more effective in containing the spread of designating isolation and treatment centers for COVID-19 using existing COVID-19 (see figure 2), but they cannot be maintained for long without buildings; preparing them with necessary medical equipment causing catastrophic economic damage. When the lockdown ends and (particularly ventilators); training community health workers; and new cases spike, an early, less intense, and more targeted mitigation conducting public campaigns on hygiene and social distancing through policy may be sustainable for a longer period. social media and, in certain cases, house-to-house visits to relieve public panic and encourage cooperation (WHO 2015; Holmes, Boyce, and Katz 2020). While some enforceable travel bans are warranted, imposing Developing Countries May Suffer More from COVID-19 In developing countries, the vulnerability to the pandemic is higher and Figure 3. The “recession” curve given an epidemic shock, containment the ability to deal with it through policy is lower than in developed measures, and coping economic policies countries. In addition to the direct effects, for developing countries Time since onset of epidemic exposed to global conditions, COVID-19 brings a sharp external demand shock. This is the case in, for example, countries in East Asia where trade and tourism are a large part of the economy (World Bank 2020a), developing countries that heavily rely on commodity exports for government revenues (World Bank 2018; The Economist 2020a), and Severity of recession those that depend on remittances from developed countries (Hausmann 2020). Some countries, such as Mexico, have balked at the economic costs of containment, while neighboring Guatemala has closed borders Blue line: With cost-effective and transportation (The Wall Street Journal 2020b). containment measures and coping economic policies More generally, developing countries may be harder hit due to the following structural conditions: Red line: With possibly excessive containment measures and without Public health. Health care systems in developing countries have low cost-effective coping economic policies capacity; many people do not have access to essential health care services and are not covered by health insurance, thereby living with the Source: Authors’ illustration partially based on Gourinchas (2020). risk of catastrophic health expenditures; and the gap between the current 3 Macroeconomic Policy in the Time of COVID-19: A Primer for Developing Countries Table 1. Indicators of public health, labor markets, fiscal space, and governance by country income group Income levels Categories Indicators Low Lower- Upper- High middle middle Public health Hospital beds per 1,000 people, 2014–18 0.69 1.32 2.18 4.20 Physicians, nurses, and midwives per 1,000 people, 2014–18 1.69 2.57 5.63 11.78 Acute respiratory infections treated as a share of children under 5 44.50 54.00 69.40 86.33 with cough and rapid breathing (%), 2009–18 Risk of catastrophic expenditure for surgical care (%), 2013–17 64.03 35.02 15.82 9.81 Life expectancy at birth (years), 2017 62.00 69.00 74.00 81.00 Labor markets Informal labor estimates as share of employment (%), 2016 92.70 83.00 55.35 14.43 Self-employed as share of employment (%), 2019 82.49 64.03 40.60 12.28 Fiscal space General government gross debt (% of GDP), 2018 46.82 53.21 50.55 56.92 General government debt held by nonresidents as share of debt (%), 2018 57.14 55.88 38.57 46.41 Domestic credit to private sector (% of GDP), 2018 14.09 27.69 48.42 110.80 Foreign currency long-term sovereign debt ratings 7.17 7.20 9.36 16.67 (Index: low of 1 to high of 21), 2018 Tax revenue (% of GDP), 2016 15.40 15.08 15.12 19.03 Governance Government effectiveness, 2018 -1.12 -0.57 -0.09 1.10 Regulatory quality, 2018 -0.94 -0.54 -0.14 1.06 Rule of law, 2018 -1.01 -0.64 -0.26 1.05 Control of corruption, 2018 -1.02 -0.62 -0.32 0.94 Source: ILO (2018, 2020); Kose, Ohnsorge, and Sugawara (2018); Loayza and Meza-Cuadra (2018); Health Nutrition and Population Statistics, World Bank (2020b); World Development Indicators, World Bank (2020c); Worldwide Governance Indicators, World Bank (2019). Note: Public health indicators are averages over the years mentioned. All other indicators are the median per income group. Risk of catastrophic expenditure for surgical care refers to the proportion of population at risk of catastrophic expenditure when surgical care is required. Catastrophic expenditure is defined as direct out-of- pocket payments for surgical and anesthesia care exceeding 10 percent of total income. and ideal health status of the average population is large (see table 1 and and resources to counter a large negative shock (see table 1 and Kose, Wagstaff and Neelsen 2019). In particular, the capacity to treat COVID-19 Ohnsorge, and Sugawara 2018). Although developing countries do not patients (that is, specialized hospital services with ventilators to cope with have larger public-debt-to-GDP ratios than developed ones, their debt is critical cases) is grossly inadequate in many low- and even middle-income more subject to exchange rate and maturity risks, their credit rating is countries. For example, Malawi has 25 public intensive care beds for a lower, and their financial markets are shallower. In addition, a small tax population of 17 million, and Zimbabwe has none (The Guardian 2020). base and less efficient tax administration mean that income support for Although developing countries have younger populations and warmer the affected and countercyclical fiscal policy are harder to implement in climates (conditions that may be associated with reduced risk to developing than developed countries. In the uncertain times of COVID-19, COVID-19), they also have higher rates of malnourishment, HIV/AIDS, and the “flight to quality” in financial markets may well mean that for some other illnesses that make them more vulnerable (The Economist 2020c; countries, it will be more difficult to borrow to cover their fiscal deficit The Washington Post 2020). (Hausmann 2020). Labor markets. Informality is rampant in developing countries (Loayza Governance. The quality of governance determines the effectiveness of a 2018). In low- and middle-income countries, 50 percent to 90 percent of country’s capacity to manage shocks and provide assistance (Kaufmann, total employment consists of informal labor (see table 1). Informal Kraay, and Mastruzzi 2011; Chuah, Loayza, and Myers 2020). Most workers lack benefits such as unemployment insurance, health insurance, developing countries suffer from corruption, lack of transparency and and paid leave. They are highly exposed not only to the health impacts of accountability, low bureaucratic competence, and burdensome COVID-19 but also to the containment and mitigation measures to reduce regulatory systems (see governance indicators in table 1). Faced with the the spread of the disease. Most informal workers, especially the challenge of COVID-19, developing country governments may find it hard self-employed, depend on daily work to pay for their basic household to conduct complicated measures to cope with the crisis. They may have necessities: if they cannot work for extended periods of time, their to rely on straightforward emergency relief and recovery policies. family’s subsistence is at risk. This means that radical suppression policies (such as lengthy lockdowns) are unlikely to be enforceable in many The structural conditions already discussed suggest that developing developing countries, as people would rather work illegally than starve. country governments face different trade-offs than those in more Moreover, extensive labor informality implies that relief and recovery advanced countries. Strict and indiscriminate containment measures are policies aimed at formal labor (such as increasing unemployment more costly, less effective, and less realistic in developing countries, while insurance, reducing payroll and income taxes, and extending paid sick their resources and ability for complex relief and recovery measures are leave) have very limited effects. limited. Therefore, developing country governments should avoid implementing policies in a haphazard way (for instance, imposing Fiscal space. Almost by definition, low- and middle-income countries do restrictions that cannot be enforced): they will cause economic damage 4 not have sufficient “fiscal space”: that is, the ability to deploy public funds without inducing significant health benefits. Rather, governments should Research & Policy Brief No.28 prefer simple, feasible, and selective public health measures that focus on Relief Measures slowing down the spread of COVID-19 and reducing human loss (as The priority of public policy in the face of COVID-19 is implementing outlined in the previous section). Likewise, developing country pragmatic and realistic public health measures (WHO 2020d). Economic governments should consider and implement economic policies for relief policy should accompany these public health measures, making them and recovery that are commensurate with their institutional capacity and financially feasible (through health care funding) and socially acceptable level of economic development. These policies are discussed next. (through compensatory measures for people and businesses). To tackle the pandemic, the following relief measures are called for. The first is an In Theory: The Role of Economic Policy increase in public health expenditures to increase the capacity of the In a world free of externalities, borrowing constraints, and insurance health care system to treat critically ill patients (raise the red horizontal shortcomings, a large adverse shock like COVID-19 would produce only a line in figure 2) and to provide free or subsidized medical attention for short-lived V-shaped recession: GDP would drop as people and firms preventative and curative purposes (ECDC 2020b; WHO 2017). The second is to provide direct income support to vulnerable populations reduce their economic activity to comply with measures to limit the through such means as cash transfers, especially when containment spread of the disease, but then everything would return to normal as measures are in place. This must be done quickly to mitigate any financial soon as the containment policies were over, with no excess strains that households may face (Gentilini, Laughton, and O’Brien 2018; unemployment or business closures. The economy could even shoot Parker and Todd 2017; Özler 2020). The third is assistance to affected above trend for a while as pent-up demand for durable goods and production sectors and firms through temporary tax cuts, moratoriums services was met. on debt repayments, and temporary credit lines (Mukherjee, In the real world, however, COVID-19 is likely to produce a prolonged Subramanian, and Tantri 2018; OECD 2009; Spilimbergo et al. 2008). and deep recession and sharp economic volatility (Furman 2020). The Consider the case of Korea, which is successfully responding to the goal of macroeconomic policy is to try to replicate this short-lived challenge posed by COVID-19. This response has been made possible V-shaped recession by mitigating the demand externalities and financing through a special fiscal budget allocation. From mid-January 2020 until constraints, utilizing monetary and fiscal instruments helping to dampen now, the government of Korea has allocated a budget of $22 billion, the impact of adverse shocks (Bernanke 2020; Blinder and Zandi 2015; around 1.5 percent of GDP, to respond to the COVID-19 outbreak. The Galí and Gambetti 2009) (see figure 3, blue line). Monetary instruments special budget has three main categories: 1) Disease prevention and include setting a policy interest rate to influence short-term market rates, treatment (around 10 percent of the budget), which includes funding for pursuing asset purchases to guide long-term market rates, providing testing, quarantine, isolation and treatment; purchasing medical liquidity, and functioning as a lender of last resort. Interest rate reductions equipment; and loans to hospitals. 2) Support for households and young primarily help increase aggregate demand by stimulating consumption adults (25 percent), through such means as cash vouchers for low-income and investment, and all monetary instruments help reduce the adverse families, childcare subsidies, and an expansion of the existing effect of financial frictions. Fiscal instruments include government employment support package for young adults (Republic of Korea, Ministry of Economy and Finance 2020). 3) Support for consumption and capital expenditures; taxes on labor income, profits, small-and-medium enterprises and local economies (65 percent), goods, and services; and sectoral allocations of subsidies, transfers, and through loans and guarantees, as well as wage subsidies to preserve tax exemptions. They can reduce the need for firms and consumers to employment. Though developing countries may find it hard to replicate borrow by providing income support. They can also counter demand Korea’s example, the basic principles can be applied in most countries. shocks: directly, by raising government consumption and investment; and indirectly, by inducing people and firms to consume and invest (via taxes First, government expenditures should be reoriented to increase and transfers). public health care capacity. Virtually all advanced and many developing economies have introduced new health spending measures. The latter In Practice: Macroeconomic Policy in Times of COVID-19 include, for example, Argentina, Brazil, China, India (0.1% of GDP), and Mexico (up to 0.7% of GDP) (IMF 2020b). The expenditures on public COVID-19 is a different type of shock: It is massive, highly contagious, health needed to cope with the pandemic is bound to differ significantly affecting both demand and supply, and leading to human and economic across countries, not only because their exposure to the disease varies crises. In this context, macroeconomic policy cannot be restricted to substantially but also because the preparedness of their health system for conventional measures. It should work in unison with complementary intensive care treatment is very different. policies in social protection, urban management, public communication, Second, government expenditures should help remedy some of the and financial and goods markets: a whole-of-government approach to economic losses produced by containment and mitigation measures, face the health emergency posed by COVID-19 (World Bank 2013). reducing the direct pain inflicted on individuals and businesses and The limited fiscal capacity of developing countries requires aligning incentives for social distancing. In fact, the support for shuttered pragmatism and prioritization. Depending on countries’ income level and businesses and furloughed workers without pay makes social distancing fiscal space, governments may resort to an increase in fiscal deficits measures possible without causing catastrophic economic damage. (preferably using sovereign wealth funds, if available, or borrowing in Likewise, this support generates the incentive for people who should domestic or external markets); budget-neutral reallocation of self-isolate to consider their symptoms and remain at home. expenditures (in case deficit financing is too expensive in current Advanced countries are implementing public provisions of wage conditions); or reliance on external grants and concessional lending subsidies, paid sick leave for workers who do not otherwise have it, (especially for low-income countries). Even in the middle of a health crisis, expanded unemployment benefits, and general cash transfers during the essential practices for macroeconomic stability and cost-efficient worst of the health emergency and the implementation of containment expenditure allocations must be followed. Therefore, inflationary measures. France, Japan, and Korea are subsiding firms and individuals financing of public deficits is not advisable, and neither is expenditure for leave taken to care for children at home during school closures reallocation that ignores basic government services or flouts governance (Gaspar and Mauro 2020). In the United States, a recently passed bill accountability. mandates paid sick leave and allows firms to claim a tax credit for it (NPR 2020). Payments of unemployment insurance benefits are being Macroeconomic policies for coping with the pandemic can be accelerated and social safety nets are being widened in China, while in organized into relief measures, recovery policies, and international Korea job seeker’s allowances for young adults have been increased coordination. (Gaspar and Mauro 2020). Broad-based one-off cash transfers have been 5 Macroeconomic Policy in the Time of COVID-19: A Primer for Developing Countries enacted in Australia; Hong Kong SAR China; and Singapore, and are being of many developing countries are taking similar steps. For instance, Brazil, discussed in the United States and elsewhere (Australia, The Treasury China, Indonesia, Malaysia, Mexico, Peru, South Africa, and Turkey have 2020; Today 2020; Financial Times 2020a; Reuters 2020). Most introduced interest rate cuts; and Argentina, Brazil, China, India, ambitiously, Denmark is introducing comprehensive packages of Indonesia, and Malaysia have also reduced reserve requirements and/or compensation for the general population during the COVID-19 crisis (The expanded their money market operations to ease liquidity conditions Atlantic 2020). (IMF 2020b). Some of these policies may be helpful in middle-income countries and Recovery Measures for workers in the formal sector, and thus deserve consideration. For example, in Chile, workers who must stay home but cannot telework will Looking forward, the policy response will change from crisis management receive unemployment benefits while retaining their formal employment to macroeconomic stimulus, though the two are connected. Although the status (Chile, Ministry of Economy Development and Tourism 2020). motivation for many of the policies already described is income support, Malaysia has a similar program whereby formal workers on leave without they also serve a wider aim of preventing a public health emergency from pay will be eligible for up to six months of a monthly cash transfer (The having second-round economic effects through layoffs, bankruptcies, and Edge Markets 2020) at an amount equivalent to half the monthly possibly financial crises. Beyond these relief efforts, macroeconomic minimum wage. Workers who lose their jobs will also get cash transfers in stimulus to prop up aggregate demand is less appropriate in the middle of Jamaica and Morocco (Gentilini, Almenfi, and Orton 2020). the containment effort, as the corresponding negative supply shock is necessary to contain the spread of the virus (Baldwin and Weder di Mauro For most developing countries, cash transfers may be advisable 2020). However, since some policies to stimulate demand act with a lag, because they are easy to implement and have wide reach outside the policies can be formulated now in the hope of boosting demand later. formal sector. When they are general and untargeted, some of the payment will end up with those who do not need it, either because they While policy interest rates are at or near zero in the United States and do not face interruptions in income or employment (such as government the European Union and in other developed countries—reducing the workers) or because they have higher income. Whether this is a big ability of central banks to cut further to stimulate the economy—most concern depends on the country-specific income distribution and labor developing countries are a long way from the zero lower bound (ZLB). market conditions. In developing countries where most of the population Ostensibly, this suggests that interest rate cuts in developing countries is either poor or near-poor and work in often-precarious informal may be a potent stimulatory tool missing in the developed world. businesses, a simple untargeted transfer is best because only a small However, there is evidence that monetary policy transmission may be fraction of the transfer will go to those who do not need it (Özler 2020). weak in many developing countries due to a lack of market-determined In contrast, in middle-income countries with a larger fraction of the interest rates (and underdeveloped financial markets more generally), population who are better off (or in protected sectors), targeted low rates of interbank competition, and exchange rate intervention payments are likely to be more cost effective and should be the focus, (Mishra, Montiel, and Spilimbergo 2012). The effect of surprise monetary especially after the worst of the health emergency. Brazil, Chile, India, policy changes on exchange rates and stock markets has usually been Indonesia, Iran, Peru, and Tunisia have announced transfers to smaller in non-OECD countries than OECD countries, Pennings, low-income and/or self-employed/informal workers adversely affected by Ramayandi, and Tang (2015) find. Prices may also be more flexible in the containment measures (Gentilini, Almenfi, and Orton 2020; Gestion developing countries, weakening the transmission from financial markets 2020; Globo 2020; Chile, Ministry of Economy, Development and Tourism to the real economy, especially in countries with histories of high inflation 2020). A consideration for pursuing targeted cash transfers to deal with (Klenow and Malin 2010). One policy option in the face of weak COVID-19 is whether they can fit in with the delivery system of existing transmission is direct lending from central bank to firms, as the Federal transfer schemes and whether the latter have proven to be effective Reserve and Bank of England are starting to do. However, direct lending is (Gentilini 2020). If no effective pre-existing system is in place for fraught with challenges—especially in a weak institutional environment. household targeting, other schemes can be considered, including using Hence, policy makers in developing countries where monetary policy is geographical targeting based on poverty maps and epidemiological/ ineffective may turn to fiscal policy to stimulate demand. containment maps. Fiscal stimulus, however, is not always effective in developing Support for businesses, from governments and central banks, is being countries and so should be used with caution. The ability of fiscal policy to provided through loan guarantees, direct lending, tax holidays, and direct stimulate economic output is known as the “fiscal multiplier,” and its size cash payments. In advanced countries, some of the most ambitious is actively debated. Empirical evidence from Ilzetzki, Mendoza, and Végh programs have been announced by the US Federal Reserve and the Bank (2013) and Kraay (2012, 2014) suggests that on average the fiscal of England. The Bank of England’s Covid Corporate Financing Facility multiplier in developing countries is small. A multiplier of zero (as in (CCFF) involves direct lending to firms facing disruptions to cashflows via Ilzetzki, Mendoza, and Végh 2013) suggests the government spending has the Bank’s purchase of large companies’ commercial paper on behalf of no effect on GDP. A multiplier between zero and one (as in Kraay 2012, the government (Bank of England 2020; Financial Times 2020b). The 2014) means that a $1 increase in government spending will increase United Kingdom will also make direct payments to small businesses and output by less than $1: that is, private consumption or private investment delay a range of taxes (Financial Times 2020c). The Federal Reserve has get crowded out. While Ilzetzki, Mendoza, and Végh (2013) find that announced potentially unlimited purchases of Treasury bills and public investment multipliers can be larger in developing countries, public mortgage-backed securities, as well as several new facilities to lend to investment is notorious for long planning, as well as approval and large and small businesses (Federal Reserve Board 2020a). In Malaysia, a regulatory delays (Leeper, Walker, and Yang 2010). This means that the special relief facility of around $500 million in guaranteed funds is projects may not be ready when the containment measures are ending. available to help alleviate short-term cash flow problems faced by small There is some evidence that persistent transfers can provide a sizable businesses (Bank Negara Malaysia 2020). In Chile, business tax payments boost to local incomes—for instance, in the United States in the short can be deferred for several months (Chilean Ministry of Economy, term (Pennings 2019) and in Zambia in the longer term (Handa et al. Development, and Tourism 2020). 2018), though those multipliers are conceptually different from the country-level stimulus multipliers already discussed. Central banks around the world are also cutting interest rates and widening lending facilities to banks to ensure sufficient liquidity and in the Fiscal multipliers depend on country characteristics: they tend to be hope that credit to businesses is not disrupted (IMF 2020b). The US larger (smaller) in countries with fixed (flexible) exchange rate regimes, Federal Reserve has eased conditions on its discount window lending closed (open) to trade, and with low (high) level of debt (Ilzetzki, through lower rates and for longer periods to help banks meet the credit Mendoza, and Végh 2013; Huidrom et al. 2019). Fiscal multipliers may be 6 demands of customers (Federal Reserve Board 2020b). The central banks much larger at the zero lower bound of monetary policy interest rates Research & Policy Brief No.28 (Ramey and Zubairy 2018), but few developing countries are at the ZLB. developing countries by providing foreign currency liquidity in their Riera-Crichton, Végh, and Vuletin (2015) suggest that the multiplier vary domestic markets through dollar swaps, as was done during the 2008 by cyclicality and the state of the business cycle. Tax cuts are also likely to global financial crisis (Georgieva 2020; Hausmann 2020). The Federal be less stimulatory in countries with low initial ratios of tax revenues to Reserve has recently extended swap lines to a number of middle-income GDP, like many developing countries (Gunter et al. 2018). Some tax-based countries, though more could be done (Federal Reserve 2020c). Likewise, stimulus packages can be less effective (and more regressive) in the IMF is considering its own swap facility (IMF 2020a). developing countries because their informal sectors are larger. For example, a payroll tax cut would not benefit low-income informal Unlike a global financial crisis, the COVID-19 pandemic carries unique workers. Given that lower-income workers may be more likely to spend epidemiological and containment-related cross-country spillovers. First, their extra income, this reduces both the effectiveness of the stimulus there are positive externalities across countries to reducing the number and makes it less equitable. of infections through coordinated action, as COVID-19 does not respect borders and second-wave infections are likely. Second, measures to The efficacy of fiscal stimulus also depends on fiscal space and contain the virus —travel bans and quarantine measures—also hurt other institutional quality, both of which may be lower in developing countries. countries connected through trade and migration linkages. Coordination Fiscal stimulus is inappropriate for countries with very low tax collection and financial support to affected developing countries are needed so that capacity—such as most low-income countries—because a stimulus they take account of both the positive and negative externalities of their package large enough to have a macroeconomic impact will lead to a actions as they tackle the disease. rapid rise in debt relative to revenues, raising the risk of default or crowding out other spending critical for development. While the costs of Conclusion debt-financed stimulus have been lowered by record-low interest rates in The COVID-19 pandemic is a massive simultaneous negative demand and developed countries, borrowing costs are rising in developing countries as negative supply shock that creates new policy challenges. In the short investors flock to safer assets. For example, since the start of the term, the focus must be on containment and mitigation measures that pandemic, investors have withdrawn more than $83 billion from slow the spread of the virus and on emergency relief measures that emerging markets, the largest outflow ever recorded (IMF 2020a). In prevent a health crisis from creating mass unemployment and countries with weak fiscal institutions, temporary fiscal stimulus can bankruptcies. The goal of macroeconomic policy in the near term is not become permanent, as in some Latin American countries after the global to stimulate the economy—which is impossible, given the financial crisis (Celasun et al. 2015). supply-restricting containment measures—but rather to support those In sum, the focus of fiscal policy in developing countries should be on affected by the public health measures. After the spread of the virus has avoiding procyclical cuts to public services, especially health services, been controlled and containment measures relaxed, attention of during the downturn. In part, this is because many developing countries macroeconomic policy can turn to more standard demand-side lack fiscal space or sizable multipliers and so fiscal stimulus is less macroeconomic stimulus. effective. But it is also because recovery from the pandemic depends on Though necessary, social distancing measures create large economic maintaining adequate health services: procyclical health service cuts can make the countries more susceptible to later outbreaks. costs. They are likely to be larger in developing countries due to the lack of market and social insurance, the high degree of informality, and the This Research & Policy Brief has simplified the policy response into limited ability of governments to provide assistance. High costs to people relief and then recovery. However, as Ferguson et al. (2020) and figure 2 and businesses may make strict containment measures less effective, as suggest, there are likely to be multiple rounds of emergency and people flout them to survive. Soon, policy makers will need to weight the recovery—as with the Spanish flu—over an extended period until a costs and benefits of various containment and mitigation measures, treatment or vaccine are found. Developing countries need to make sure noting that the more restrictive the measure, the shorter it can be applied that they reserve fiscal space to fight these later outbreaks. without creating an economic disaster that undermines broader development and social goals. International Cooperation The macroeconomic recovery response to the COVID-19 pandemic in The COVID-19 pandemic is a truly global shock that motivates a developing countries may involve both monetary and fiscal stimulus. coordinated global response. As before, the first priority should be However, as monetary transmission tends to be weak, fiscal space is boosting health systems. As such, the World Bank Group is providing $6 limited, and fiscal multipliers are often small, the effectiveness of billion in loans and assistance to developing country governments to demand-oriented macroeconomic policy may be low in many developing strengthen public health care, as part of a broader $14 billion assistance countries. Instead the main goal, rather than stimulus, should be package (World Bank 2020d). Because of the particularly precarious continuity of public services—including health care—and support to the position of low-income countries, the international community will need vulnerable. to provide support, particularly in the event of a drawn-out pandemic, by transferring technologies for testing and early detection of cases of A global, highly contagious shock like COVID-19 requires international infection, increasing the peak capacity of weak health care systems, coordination that internalizes the positive externalities of reducing first- facilitating shifts toward greater service delivery and income-generating and second-wave infections and the negative externalities of unilateral activities that are consistent with social distancing through investments in actions that hurt other countries economically. Given the magnitude of digital infrastructure, and ensuring health system readiness for the the negative shock that COVID-19 represents, international cooperation deployment of a cure and vaccine when they become available. will be needed as developing country governments see their revenues drop and their access to financial markets dry up. International Developing countries are likely to find that at the very time they need coordination and cooperation may yet prevent the worst effects of the to increase their budget allocations for health care and income support, COVID-19 pandemic. their revenues have decreased because of the recession and international funding markets have dried up because of increased risk aversion. 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