14 Dec 2020

Where consumption falls in times of Corona, sovereign debt rises

The third online conference day of the Frankfurt Conference on Financial Market Policy 2020 makes clear that the Corona crisis casts long shadows on household incomes and aid measures in Europe

The actual severity of the economic consequences of the corona pandemic can particularly be seen in the way Europe's populations and countries are reacting to this crisis. While consumption has plummeted almost across the board, public debt is skyrocketing. In the long term, not only growth in the European Economic Area will suffer, but also its social security systems. The political response to this development was the focus of the panel debate on the third day of this year's Frankfurt Conference on Financial Market Policy, which is being held as a web conference for the first time.

"Virtually all households are affected," Andreas Hackethal opened the panel discussion on "The Corona Pandemic and Household Consumption: How Should an Effective Stimulus Package Look Like?" The director of SAFE's Household Finance research department did not only underscore the impact of the Corona crisis on different household incomes. His presentation of the results of a large-scale household survey in Germany – summarized in a SAFE White Paper – also highlighted the variance in the effectiveness of government-created stimulus packages to address the pandemic.

Covid shock hits low-income most of all

The two representatives of EU institutions on the online panel – economists Maarten Dossche from the European Central Bank and Philipp Mohl from the European Commission's Directorate-General for Economic and Financial Affairs – backed up Andreas Hackethal's remarks with data from their respective institutions. The ECB's “Consumer Expectations Survey” (CES) shows very heterogeneous effects regarding the savings behavior and consumption of the population in the euro area, Dossche described. Especially at the lower end of the income distribution, households are exposed to the Covid 19 shock, which limits their liquidity and thus their consumption, he said. "These people have to borrow money or use their savings to cover spendings," Dossche said. As a result, he said, the mass of government support is focused on these income groups.

Compared with the US, the Corona crisis hit the euro zone earlier. The Americans, in turn, had responded with larger aid packages, but these were less targeted, the ECB economist explained. In Europe, the most extensive aid packages were launched by Germany, France and the Netherlands, Philipp Mohl continued, which were also very targeted. However, it would be problematic if these packages were no longer only used temporarily, but permanently. According to Mohl, sovereign debt will increase by more than 100 percent of GDP at the aggregate EU level in the wake of the Corona crisis. Real GDP will shrink by eight percent in 2020 and will still be below the pre-pandemic level in 2022, measured in terms of economic output.

Corona-induced debt is a long-term burden on social safety nets

"The optimal policy design very much depends on the length and severity of the pandemic," Mohl pointed out. As the crisis unfolds, fiscal policy regains importance relative to monetary policy, he said. "Complexity matters for the effectiveness of policy measures," agreed Michael Weber of the University of Chicago Booth School of Business, but countered, "communication manages expectations." For example, Weber said, households that have to live more hand-to-mouth actually tend to spend two-thirds of government funds they receive on consumption, while as income rises, the share of spending falls. In order to encourage people to consume more, it is crucial how clearly this is communicated.

SAFE Fellow Alexander Ludwig, who moderated the debate, finally pointed to the cost side of government spending programs to combat the Corona crisis. Future generations would be faced with huge amounts of debt that would far exceed the volume of social safety nets. In addition, future households would not only have to contend with high sovereign debt but would probably also have lower incomes at their disposal. To make government aid packages thus crisis-proof and sustainable the fiscal multipliers would have to have a value greater than one.

Watch the full length video of the third session of the Frankfurt Conference on Financial Market Policy 2020