A Traditional Economic Stimulus Won’t Work. Here’s What Might.

More countries should follow Denmark’s example

A man walks through the U.S. Capitol Rotunda, empty of tourists as only essential staff and journalists are allowed to work.
A man walks through the U.S. Capitol Rotunda, empty of tourists as only essential staff and journalists are allowed to work during the coronavirus pandemic on March 24, 2020 in Washington, DC. Photo: Chip Somodevilla/Getty Images

AsAs the Covid-19 pandemic brings the U.S. economy to a standstill, a severe drop in consumer demand is putting vast numbers of businesses at risk of bankruptcy, and millions of employees at risk of losing their jobs. With the U.S. government preparing to spend up to $2 trillion to help workers and shore up businesses, a key question remains: Which interventions will be most effective?

Unfortunately, traditional stimulus measures are unlikely to solve this problem alone. Such measures, including interest rate cuts by the Federal Reserve, or stimulus checks mailed to U.S. households by the Treasury, seek to fight a drop in demand by encouraging households to spend more. But while a traditional stimulus package might work in a normal recession, it is poorly suited to the current environment for two reasons.

First, given the risk of infection, consumers may rationally be extremely averse to certain types of activities, such as dining in at restaurants, even if they feel they are affordable. Moreover, public health measures closing businesses or mandating shelter in place may make these activities impossible even if consumers are willing to take part. Second, to the extent that these policies are successful, they may be counterproductive by encouraging activities that are incompatible with social distancing, thereby accelerating the spread of infection.

What might work better is a temporary program of public furlough assistance that allows firms to place workers on paid leaves of absence. This proposed program would permit businesses to temporarily furlough workers, up to a limit of say, 90 days, with the government replacing part or most of their salaries. The businesses would be required to maintain each worker’s health coverage during the furlough, and return them to employment afterwards. This program would be similar in some ways to traditional unemployment insurance, but would allow the worker to collect benefits without being laid off, avoiding painful unemployment spells for workers and, just as important, any disruption in employer-based health insurance.

Businesses would be able to temporarily cut labor costs, helping to keep them afloat in difficult times, while workers would be able to maintain their incomes and benefits without permanently losing their positions.

What would be the benefits of such a program?

First, it would help adversely affected businesses and their workers at the same time. Businesses would be able to temporarily cut labor costs, helping to keep them afloat in difficult times, while workers would be able to maintain their incomes and benefits without permanently losing their positions.

Second, the program would be targeted — automatically directing relief toward the sectors of the economy that need assistance the most. How would this happen? The key is that only businesses facing severe drops in demand, like restaurants or airlines, will want to temporarily cut their labor force. Firms that may boom during the quarantine period, such as those providing teleconferencing software, or whose employees can easily work from home, may instead want all hands on deck, and therefore incur no expense to taxpayers under this program. The idea is that while a broad array of firms would have the option to impose these furloughs, only firms facing low demand would have the incentive to actually use them.

Third, this program would provide assistance without encouraging any additional economic activity that could spread infection. Unlike traditional stimulus measures, it could help restaurant owners and staff without a single additional dine-in meal being served. On the contrary, it provides a way for businesses to remain viable while intentionally cutting back on operations.

By enabling workers to stay at home without fear of infection or job loss, public furlough assistance could be the difference between a rapid post-quarantine recovery and a protracted economic and public health catastrophe.

Fourth, public furlough assistance would allow workers in some of the jobs most prone to infection to keep their paycheck while waiting out the epidemic safely at home. Alternative proposals that would help businesses with no strings attached might fail to prevent these workers from being laid off, while policies that would encourage businesses to retain employees may see them still required to report to work. A system of paid furloughs is unique in its ability to prevent the destruction of jobs while simultaneously keeping workers safe and promoting public health.

Fifth, the program would not be a bailout of irresponsible corporate behavior. Public furlough assistance would not advantage companies with excessive leverage or a shaky financial position over firms that took more prudent actions leading up to this crisis. For better or worse, furloughs will not be appealing for truly insolvent firms that need to lay off workers or shut down. Instead, the program would provide equal opportunities for relief to all firms wishing to temporarily scale back their operations.

A number of countries, including Belgium, Denmark, France, Germany, and the United Kingdom, are already implementing programs to share labor costs for firms cutting back on hours or operations. Denmark in particular has led the way with an ambitious three-month plan called the Temporary Compensation Scheme that replaces 75% of workers’ salaries at qualifying firms, with the goal of preventing mass layoffs. Policymakers in the United States should strongly consider doing the same through public furlough assistance.

For maximum effect, the program should be paired with a companion policy, again following Denmark, to help pay for fixed costs such as leases of firms facing low demand. This is good policy on its own, since these costs can also imperil the health of affected firms, putting their employees’ jobs at risk. But making these benefits more generous for firms furloughing workers would strengthen both policies by: (i) further incentivizing firms to furlough rather than lay off workers, and (ii) improving targeting by ensuring that fixed-cost relief flows to firms that are actually contracting operations. To lock in employment gains, these benefits should be tied to keeping furloughed workers on payroll for a minimum time (for example, six months) following their return. Finally, a provision allowing the self-employed to “self-furlough” is essential to make sure these workers are not left behind.

All told, public furlough assistance would not be cheap. Furloughing 20% of workers for three months with 75% salary replacement could have a sticker cost of $350 billion, although much of this cost would likely be recouped by preventing layoffs, reducing unemployment insurance outlays, and increasing tax revenue.

But with government borrowing rates effectively at zero, this cost is a bargain compared to the potential gains. As we saw in 2008, mass unemployment can lead to devastating and long-lasting consequences, both economic and social. The Covid-19 pandemic will challenge us further by linking economic activity to the spread of potentially deadly illness. By enabling workers to stay at home without fear of infection or job loss, public furlough assistance could be the difference between a rapid post-quarantine recovery and a protracted economic and public health catastrophe.

A version of this was originally published on dlgreenwald.com.

Assistant Professor of Finance at the MIT Sloan School of Management, researching links between finance and the macroeconomy.

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