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Thursday, April 23, 2020

The Pandemic Normal: Whither Income Flows?

I see very few reasons to expect a return to pre-COVID normal in most countries any time soon. Countries will need to adapt to the "pandemic normal," where activities will have to in line with preventing super-spreading incidents. Right now, the economic concern is cascading business/household failures. Fiscal deficits will put a floor under that process. What will the new steady state look like? The main interesting question is how income flows are re-shaped.

The Pandemic Normal

Governments, including Singapore, and the Ontario and Quebec provincial governments have moved to emphasising two categories of transmission: community transmission, and infections among communal populations. Important examples of these communal populations include nursing home residents (main source of deaths in Canada), guest workers in Singapore, penitentiary inmates, North American meat packing plant workers, sailors, etc.

The transmission rate for these communal populations is extremely high. For the rest of the population that has been warned about the virus (and is taking precautions), the transmission rate is quite low, most likely just less than 1 in most developed countries. The aggregate infection growth rate is the weighted average of those two rates.

Health policy will converge across countries, with two legs.
  1. Protect communities that have inherently high transmission rates.
  2. Shut down activities that create super-spreader opportunities, and let other activities that meet safety regulations continue.
The only real debate will be which activities are safe. My assumption here is that a lot of activity is fine, but things like air travel, sports events, theme parks are definitely out, and indoor activities will be limited. 

Note that I am putting aside the possibility of a V-shaped recovery. Although such an outcome seems possible, it seems unlikely in most countries.

Steady State Flows

Assuming that the downward economic spiral is halted and any mechanical bounce back, the economy will return to a steady state growth rate. My assumption is that the steady state unemployment rate will at least initially settle at a level above 10% in countries that have not largely eliminated the virus via mechanical means. (Those countries could see something like a V-shaped recovery, as they might be in a position to ramp up exports to match production problems elsewhere. For example, New Zealand might be able to step up meat exports as North American meat packing plants are mired in shut downs.)

The argument is straightforward: a lot of labour-intensive activity in the service and retail sectors will be exactly the ones that cannot be safely done under the new conditions. Furthermore, some industries will be shuttered (like passenger air travel), but industries will be mothballed against a future recovery.

A high unemployment rate will imply large government deficits. (See discussion on austerity below.) Although many commentators just focus on the alleged evils of deficit spending, the reality is that deficits are a cash inflow to the non-government sectors. The question is: where is the money going?

Slow Growth Option: Savings

It seems clear that savings will absorb some of the income flows from government.
  • For people who are employed or pensioners, their spending options are highly limited (particularly for safety-concerned pensioners who are effectively living under house arrest). For example, it can be much cheaper to prepare food at home than dining at restaurants. Meanwhile, economic uncertainty and low interest rates will tend to raise precautionary savings.
  • Entities that receive fixed payments from households (rent, mortgages) might hoard the income.
  • Housing markets may be impaired, which will reduce the dis-saving associated with new mortgages. (The existing mortgage stock represents a source of forced savings.)
It seems reasonable to expect these sources of savings to soak up some of the fiscal deficits, but my back-of-the-envelope guesses at magnitudes suggests to me that they are not enough.

External Sector

Increased expenditures on imports seems possible in a world of supply chain disruptions. However, not every country can simultaneously run up a trade deficit. However, the same supply chain disruptions make it hard for volumes to rise. Seems like this channel will be too small to significantly offset deficits for larger countries.


Rising prices could soak up nominal spending flows. Although certain goods are certainly increasing in price, it is hard to see such an outcome being compatible with a high unemployment rate.

The main inflation scare story seems to be food-based. However, a lot of that involves the impairment of large meat-packing facilities in North America. The extreme concentration of industrial food production that is a characteristic of North America is not universal, and so it is unclear how far this will spread. North Americans will be forced into other protein sources.

Fixed Investment

By process of elimination, we are left with fixed investment. Given how the crisis highlighted the vulnerability of supply chains, the amounts of ill will that has been raised between countries, and the impairment of passenger flights, the prophecies about on-shoring production might finally come true.

(One local anecdote is the renewed interest in Quebec about increasing greenhouse production to provide a stable source of fresh fruit and vegetables in winter.)

Meanwhile, there will need to be extensive investment in making places safe to work/congregate in an environment with lurking virus risks. For examples, office buildings might need to rip out all the open plan offices installed over previous decades.

This channel is bullish for risk assets, as fixed investment is a source of profits via the Kalecki Profit Equation. (As are fiscal deficits, although we need to be careful of not double-counting.) [Update: added this in response to a couple online comments.]


One could imagine fiscal conservatives attempting to use austerity policies to control deficits (or the default risk on sub-sovereigns forcing them to rein in deficits).

I do not expect any immediate attempts to impose austerity policies. Right now, outside the euro area, the only parties that I am aware of that might be concerned about government debt are out of power (such as the Democratic Party, U.K. Labour Party).

Instead, austerity might be attempted once the recovery is underway. In particular, a Biden administration would almost certainly be hit by Republicans protesting government spending and debt. As the last cycle showed, spending cutbacks will hobble demand, keeping growth rates slow, and so there will still be persistent deficits.

Concluding Remarks

The government sector is going to be ramming money down the mouth of the non-government sector. Sooner or later, it will have to come out somewhere.

(c) Brian Romanchuk 2020


  1. If it ends up being fixed investment isn't that akin to saying corporate profits (per kalecki)? The irony of our response to this crisis is that inequality may explode upwards.

    1. Yes. I also got a comment to that effect on twitter. Will update to explicitly note that...

    2. The purpose of capitalism is to accumulate capital on the assumption that capital formation is the basis of growth and "a rising tide lifts all boats." This favors owners of capital, both real and financial, politically as well as economically. Asymmetrical distribution is expected. The only question is how much disparity is built into the institutional arrangements of the system as a political choice.

  2. "The government sector is going to be ramming money down the mouth of the non-government sector. Sooner or later, it will have to come out somewhere."

    I take a thrust at suggesting where and how much in an article that I posted this morning. "Relief Money Doesn't Just Disappear"

    What I did not cover in my article was the macroeconomic effect of all this new money on the national capital structure. In my view, this new money the government is deploying is more appropriately labeled as a deployment of 'capital'. Unfortunately, this would be a deployment of new capital, yielding a macroeconomic effect akin to the issuance of additional stock in a company. I won't try to develop this concept in this comment.


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