Covid is forcing economists to look at other disciplines for recovery clues

Larry Elliot in The Guardian

Three times a week an update on new Covid-19 cases is published by the economics consultancy Pantheon. Vaccination rates are monitored by the Swiss bank UBS. The scientists advising the government are in regular contact with the Bank of England’s monetary policy committee – the body that sets interest rates.

Richard Nixon may or may not have said “we are all Keynesians now” after the US broke its link with gold in 1971 but one thing is for sure: all economists are epidemiologists now. And there’s a downside and an upside to that.

The downside is that economic forecasting is currently even more of a mug’s game than usual because even the real (as opposed to the amateur) epidemiologists don’t really know what is going to happen next. Are there going to be new mutations of the virus? Assuming there are, will they be less susceptible to vaccines? Will Covid-19 go away in the summer only to return again as the days get shorter, as happened last year? Nobody really knows the answers to those questions.

The upside is that the pandemic has forced economists to look beyond their mechanical models and embrace thinking from other disciplines, of which epidemiology is just one.

For a start, it is hard to estimate how people are going to react to the easing of lockdown restrictions without some help from psychologists. It is possible that there will be an explosion of spending as consumers, in the words of Andrew Bailey, “go for it”, but it is also possible that the second wave of infection will make them a lot more cautious than they were last summer, when there was still hope that Covid-19 was a fleeting phenomenon.

An individual’s behaviour is also not entirely driven by their own economic circumstances. It can be strongly affected by what others are doing. If your peer group decides after having the vaccine that it is safe to go to the pub, that will probably affect your decision about whether to join your mates for a drink, even if you are slightly nervous. Sociology has a part to play in economic forecasting.

As does history, if only to a limited extent, because there are not a lot of comparable episodes to draw upon. A century has passed since the last truly global pandemic and there is only so much that can be learned from the outbreak of Spanish flu after the first world war. But when Andy Haldane, the chief economist of the Bank of England, says the economy is like a coiled spring waiting to be unleashed, that’s because he thinks there are lessons to be learned from the rapid recovery seen last summer. Back then, the economy followed a near 19% collapse in the second quarter of 2020 with a 16% jump in the third quarter.

Naturally, economics has a part to play in judging what happens next. Millions of people (mostly the better off) have remained in work on full pay for the past year but have struggled to find anything to spend their money on. Millions of others – those furloughed on 80% of their normal wages or self-employed people who have slipped through the Treasury’s safety net – are less well-off than they were a year ago and may fear for their job prospects.

In an ideal world, the better-off would decide that the amount of money saved during lockdown was far in excess of what they needed and would then go on a spending spree: heading out for meals, taking weekend breaks, buying new cars; having their homes re-decorated. That would provide jobs and incomes for those on lower incomes.

But it might not work out like that. If the better-off leave their accumulated savings (or most of them, at least) in the bank, that means higher unemployment for those working in consumer-facing services jobs – such as hotels and restaurants – and an economy with a dose of long Covid.

There are two conclusions to be drawn from all of this. The first is that precise forecasts of what is going to happen to the economy over the next year, or even the next few months, should be treated with caution. Assuming the vaccination programme continues to go well, assuming that there are no further waves of infection, assuming restrictions are lifted steadily from early March onwards, and assuming that people come out of hibernation rapidly and in numbers, then the economy will start to recover in the second quarter. But there are a heck of a lot of assumptions in there: it might take until the third quarter for the bounce back to begin; the recovery might prove weaker or stronger than the consensus currently expects.

The second conclusion is equally obvious. If, as is clearly the case, the existence of so many imponderables makes precision forecasting more difficult than normal, it makes sense for economic policy makers to act with caution. For the Bank of England, that means no dash to embrace negative interest rates, which won’t be necessary if Haldane’s bullishness proves to be justified; and for the Treasury it means extending financial support and ignoring calls for higher taxes, especially those that might lead businesses to collapse or cut back on investment.

It would appear that Rishi Sunak has reached the same conclusion. There has been far less talk from the chancellor recently about the need to reduce the UK’s budget deficit, a process that has now been delayed until the second budget of 2021 in the autumn. By that stage, it might well once again by Sunak rather than the epidemiologists running the economy. Well, perhaps.