The Corona Crisis Seen from a Macroeconomic Perspective

Motoshige Itoh
Professor Emeritus, The University of Tokyo
Professor, Faculty of International Social Sciences, Gakushuin University

Importance of Macroeconomic Perspective

The novel coronavirus is causing the gravest international crisis since the end of WWII. The effects of the COVID-19 pandemic on the economy, politics, and society are subject to analyses from various perspectives. When it comes to economic analyses and discussions on the current crisis, they center around two points --- "life with corona" and "post-corona life" --- probably a little simplified, but the argument makes a valid point.

People discuss various issues related to "life with corona" --- how to control the spread of infection, how to balance infection control and the maintenance of economic activities, and how to prevent the collapse of the medical system. Immediate economic policy responses should be studied also to address these urgent issues, since the world is facing the risk of another major outbreak, and the possibility of second and third waves of infection is plausible.

Discussions on "post-corona life," on the other hand, consider what the post-corona world will be like due to significant social changes occasioned by the corona crisis, or the state of the so-called new normal. The post-corona world may be subject to analyses from various perspectives such as politics, international relations, and society in general. If limited to the economy, there are many interesting issues. Particularly in the corona crisis, the digitalization of society will accelerate, as teleworking, remote education, and online medical consultation become prevalent.

Such changes will work as a catalyst for changing the way people work. We must practice social distancing for the time being, which will change the look of cities and the modes of commuting. In the realm of education, the fusion of online and offline education will bring about significant changes in the conventional education system. The implications of these changes --- changes in university education, review of the entrance examination system, and the expansion of recurrent education --- may be beyond our imagination.

Discussions on "post-corona life" are undoubtedly vital. Crises were and are in whatever age a major driving force for making changes in conventional systems. Many of these changes are not necessarily desirable, but they can be accompanied in many if not all cases by creative destruction that breaks a stifling situation.

This paper will consider the impact of the corona crisis from a different perspective from either "life with corona" or "post-corona life." Emphasis will lie on discussion from an economic perspective that seems to be rather missing in discussions on "life with corona" or "post-corona life."

The economy is an intricate system. If some grave shock occurs in a part of it, a chain of multiple changes will take place in that system. Those changes will inflict a still significant impact on the economy. What I would like to emphasize here are macroeconomic aspects that include finance and global economic activities. It is unlikely that a shock like the corona pandemic will not have a grave impact on the financial system. Actually, it has already had a profound influence on fiscal management. Mounting stress on finance would cause even serious disturbance to the fiscal/monetary system. The disruption of the fiscal/monetary would cause further economic upheaval.

The global economy should also be a focal issue. Before the corona crisis, the global economy had already faced a crucial turning point --- the US-China trade friction, the spread of global populism, and the weakening of the WTO and other international systems. The corona crisis is stopping global activities by making the transborder movement of people impossible. Even if people can move again in the medium term, the global economy is unlikely to be where it was before the corona crisis. It is predicted that the US-China friction will become more severe and that the review of supply chains will change the flow of trade and investment.

These movements in finance and global economic activities are associated with both "life with corona" and "post-corona life." In any case, they cannot be discussed separately from the corona pandemic. However, it seems that the public debate falls too distinctively into the urgent issue of "life with corona" and the issue of "post-corona life" that can be considered separately from questions at hand. Comprehensive discussions should take place on economic issues associated with the corona crisis.

The Great Depression

The IMF forecasts on the global economy predict that the world economic growth rate for 2020 will be the worst since the Great Depression in the 1930s. Predictions from other international organizations bear a similarly pessimistic outlook. In consequence, many discourses compare the corona crisis with the Great Depression.

A significant feature of the Great Depression is that it lasted for a long time. Reportedly, the Wall Street Crash of 1929 triggered the Great Depression. It took many nations more than ten years to get out of the recession. Why did the recession last so long? Whether lessons learned from the Great Depression are instrumental for us to address in the corona crisis is a cardinal point of discussion.

When the corona crisis began to spread in the world, many people shared the optimism that this crisis would not last too long. Federal Reserve Bank chairman Bernanke likened the corona crisis to a snowstorm in an interview with CNBC. "Going out in a snowstorm is never a good idea; you must stay home --- lockdown." However, this metaphor is somewhat misleading, if it is understood as: Any snowstorm will pass in a week; economic activities will return to normalcy once the snowstorm has abated.

The fact that a V-shaped recovery was debated in the early stage of the corona crisis is related to such an outlook. Even now, expectations for a V-shaped recovery remain strong. Now in July, when I am writing this paper, financial indicators such as stock prices were strong, but not so for the real economy. The financial markets seem to be optimistic about the future economic outlook. I will return to this point later.

Nearly five months have passed since the global outbreak of the corona crisis, and such optimism that the effect of the infection may be short-lived has receded. If the influence of the infection lasts for the time being, we should rather look back at the lessons learned from the Great Depression, during which a deep economic recession continued for a long period of time.

Behind the prolongation of the Great Depression in the 1930s was a critical disruption in national finance and the global economy. The Wall Street Crash of 1929 may have triggered the Great Depression; yet, the protracted recession was accounted for by subsequent problems of national finance and the exchange of protectionist policy measures. F (financial) and G (global) problems created a vicious circle in the economy. Such a mechanism is always latent in the economy. A vicious circle that occurs in finance or trade investment will prolong a recession. Regarding the corona crisis, we have to pay attention to F and G problems.

This paper will focus on the financial aspect. Nonetheless, the global aspect is also quite important, but due to limitations of space, and to the fact that another article I am preparing at this moment along with this one will provide insights on the global aspect. (The other one will soon appear in the journal "Diplomacy" of Toshishuppan Inc.)

Low Growth, Low Interest Rates, and Low Inflation

Facing the corona crisis, governments around the world are expanding their fiscal spending on an unprecedented scale. The central banks continue injecting money in the market on the largest-ever scale. Without such a bold fiscal and monetary policy, we could not respond to the imminent crisis. Details apart, therefore, a bold fiscal and monetary policy is essential. However, will such an unprecedented fiscal and monetary expansion not have any adverse effect on the future economy? Many people may not be free from such anxiety.

A vital point in understanding the state of finance is the so-called three lows --- "low interest rates, low growth, and low inflation." This state of finance has continued for a long time since the end of the Lehman shock, and has become even more remarkable in the current corona crisis. Many governments are undertaking enormous fiscal spending, and public debts are increasing. Many central banks have purchased a large number of government bonds and continue to inject money in the market. Despite these policy measures, or as a consequence of them, interest rates have remained at record lows, and the economy is sluggish. Both the inflation rate and economic growth rate are quite low.

In Japan, this situation has been continuing since the financial crisis in the late 1990s. As a result, such a deflationary situation is called "Japanification." At the time of the Lehman shock, many governments and central banks undertook bold fiscal spending and monetary expansion policies. To respond to the corona crisis, they have further expanded the scale of their fiscal and monetary policies.

Since the economy is sluggish due to the corona crisis, it is no wonder that the inflation rate and economic growth rate are also low. As monetary easing is proceeding on a large scale, interest rates have fallen to unprecedented low levels. Many people may think, "Nothing bizarre is happening." But the disparity is increasing between high stock prices and buoyant financial markets on the one hand and the weakness of the real economy on the other hand, and the public debt continues to expand. Many people may worry about until when these three lows will continue.

The Japanese situation where the three lows have continued for long is watched with astonishment because Japanese public debt has continuously exceeded 200% of GDP, but interest rates have remained low. How long will the public debt continue to expand? Experts have kept a watchful and anxious eye on the situation.

That the private economy is flagging lies in the background of low interest rates, low growth, and low inflation over a long time. It is called secular stagnation. Long-term interest rates, which also represent yields on Japanese government bonds, have been on the decrease for the past 30 years. This decline in long-term interest rates went along with that in productivity and growth rate. Weak private demand for funding is also considered a factor contributing to low interest rates.

As for funds flow, there are surplus funds in the private sector, while the fiscal deficit is chronic in the public sector in a way just to offset the private sector's surplus. In other words, the public sector is plugging its deficit with the private sector' surplus funds. Although the swelling fiscal deficit and public debt may seem to contribute to raising interest rates, massive monetary easing is putting downward pressure on interest rates. As a result, current low interest rates are helping significantly to reduce yields on Japanese government bonds. If long-term interest rates are on either side of zero, yields on additional government bonds will not increase.

The increase of the government debt is worrisome, but the government deficit will be made up for by the private sector's surplus funds; low interest rates will keep yields on government bonds low. This situation seems to continue for the time being. Although the economy lacks vigor because of low growth and deflation (low inflation), the current situation is strangely stable.

Due to the corona crisis, all major countries have fallen into the state of three lows. They made responses on an unprecedented scale, both in terms of fiscal deficit and financial expansion. There is uncertainty about how finance will evolve.

A Scenario for Raising Interest Rates

Although there prevails a feeling of stagnation in society, the situation of three lows is in a sense stable. A paramount crisis, however, may destroy such a sense of stability. The economic measures currently implemented to deal with the corona pandemic by the governments and central banks of the world's major countries are so massive in scale.

If the state of the three lows collapses, it will begin with interest rates. The growth rate will not rise sharply. As for the prices of goods, it is difficult to imagine that prices will suddenly increase, given the world's deflationary situation. Of course, since the corona crisis has left a profound scar on the global supply chain, the possibility cannot be denied that prices will be affected if something wrong happens with the recovery of supply.

If interest rates begin to rise, it will be when the economy will recover from the corona crisis. In the process of economic recovery, the private sector's demand for funding will grow. But if the fiscal deficit shrinks in a way to offset the private sector's increasing demand for funding, capital markets as a whole will not raise interest rates. Given that the current level of interest rates is too low, it is hard to think that interest rates will not rise at all during the economic recovery.

Of course, it is not a bad thing that interest rates rise. If interest rates remain too low, the resource allocation function of interest rates will weaken. For example, even a company that should otherwise leave the business can survive thanks to low interest rates. Such is a so-called zombie company. Many people have already pointed out that the continuation of low interest rates will weaken the resource allocation function of interest rates, causing an economic downturn and the continuation of deflation.

The economies of leading countries remain sluggish due to the corona crisis. The sooner we can get out of the current situation, the better. But we must assume that long-term interest rates will then rise. Since, however, the effects of the corona crisis cannot be swiftly eliminated, the economic downturn will arguably last for a long time. In that case, ultra-low interest rates may continue for the time being.

In the following, I will continue with the scenario that the economy will eventually recover. Economic recovery will raise interest rates, which is not bad for the private economy. The rise of government bond yields will lower the price of government bonds; yet, as long as the decline is minimal, its direct impact on financial markets and financial institutions will be limited.

What matters is the public sector. The larger the size of public debt, the greater the interest burden due to the rise of interest rates. Let's try a simple calculation. Under the influence of the corona crisis, Japanese public debt is expected to increase to approximately 240% of GDP. If yields on this public debt increase by 1%, the interest burden on the debt will be 2.4% of GDP. If we want to raise this amount of income depending only on consumption tax, the amount will be equal to the revenue corresponding to the tax rate of nearly 5%. The increase of tax revenue deriving from the raising of consumption tax rate under the Abe administration would vanish with a one percent rise in interest rates.

The interest burden on government bonds is the interest rates at the time of issuing government bonds in the past. Even if interest rates rise now, it does not mean that the interest burden on past government bonds will increase immediately. However, if interest rates rise, the current interest rates will be replaced by higher interest rates at the time of refinancing government bonds; therefore, the burden of rising interest rates will gradually increase.

What matters here is the market reactions to the bond interest burden borne by national finance, rather than the increase of the bond interest burden in national finance. If the rise of interest rates undermines the market confidence in national finance, it means that the lack of confidence in national finance will become a factor for lifting interest rates. Long-term confidence in national finance is a primary condition for maintaining low interest rates, but once that confidence wavers, interest rates on government bonds are likely to rise.

Here, I would like to look back on the financial situation since 2013, when the Abe administration was inaugurated. The administration's fiscal management had two main pillars. The first is the flexible use of fiscal policy to break out of deflation. The first pillar did not regard fiscal improvement as a supreme priority but aimed at employing fiscal stimulus packages as needed.

The second pillar is a commitment to medium- to long-term financial improvement. The initial goal was to halve the ratio of the fiscal deficit to GDP by 2015 and turn it to a surplus by 2020. Although this target was not fully achieved, the fiscal deficit continued to shrink, and the public debt-to-GDP ratio began to decline.

Unfortunately, the corona crisis has destroyed this course of financial improvement. The fiscal management needs a review again when the economic recovery from the corona crisis begins. It has now become rather difficult to suppress the rise in interest rates and carry out financial improvement during an economic recovery.

In the meantime, there is a pessimistic scenario that the deflationary situation will, as in the past, continue in Japan and interest rates will not rise. (As a result, however, no serious financial problem will occur.) Looking at the situation that the country has found itself in, it is a plausible prediction that such a stagnant scenario will unfold regardless of the corona crisis. Many market specialists and policymakers may share such a view.

Will this kind of stifling situation continue even after the corona crisis? The corona crisis has brought the Japanese financial situation to a new phase. What is noteworthy about the current crisis is that all advanced industrialized countries have undergone "Japanification." Interest rates are likely to start rising once the economy recovers. Even if the Japanese economy may not be quick to recover, economic recovery will begin, for example, in the United States at some point in time, and interest rates will rise.

If interest rates rise in major countries around the world, including but not limited to the United States, in the process of breaking out of the corona crisis, the move will affect interest rates in Japan. The world economy is declining concurrently due to the corona crisis; a simultaneous global economic recovery would all the more likely have a significant impact on interest rates in Japan.

From Liquidity Quotation to Solvency Quotation?

As already mentioned, there is a large disparity between financial markets and the real economy. When the global stock markets fell sharply in March, financial markets reacted considerably to the corona crisis. In bond markets, the spread between high- and low-risk bonds began to widen, and government bond yields in emerging countries such as Brazil, Turkey, and South Africa tended to rise.

These movements in financial markets were modified in April. The recovery of stock prices was remarkable, and the stock index of NASDAQ, which has many high-tech stocks, continued to soar. Bond spreads shrunk, and government bond yields in emerging countries, which had been on an upward trend, also showed a downward trend.

If the real economy is on a recovery trend, such recovery of financial markets is natural. However, the real economy remains still stagnant due to the corona crisis. Whether the disparity between financial markets and the real economy will continue as it does has become a significant point in considering future economic development.

As long as financial markets are not short-sighted, their situation may reflect the future of the economy, and the real economy will eventually recover. In the early stages of the corona crisis, there was a lot of hope for a V-shaped recovery. But seeing the spread of infection and its impact on the economy, such expectations have dwindled.

If the real economy will take time to recover, I am wondering whether financial markets, which deviate far from the real economy, will continue to be firm. Such a disparity between the real economy and financial markets is a phenomenon that was more or less observed before the corona crisis. In the years following the Lehman shock, the recovery of the real economy was slow, while stock prices continued to rise significantly. Since the downturn of the real economy this time is massive, it is no wonder that this disparity has widened further.

The theoretical value of the stock price represents the current discounted value of profits that a company will generate in the future. If expectations for future profits do not change, but if the interest rate (that is, discount rate) falls sharply, the theoretical value of the stock price will rise. Thus, we can explain why stock prices will remain strong despite the decline of the real economy under ultra-low interest rates in the post-corona world. Some people analyze that the present state is a corona bubble, but high stock prices at low-interest rates do not necessarily represent a bubble.

Stock prices dropped precipitously in March due to the corona crisis but recovered thanks to large-scale fiscal and monetary policy packages of governments and central banks. From this, we can say that current firm financial markets are sustained by various fiscal and monetary policy measures. Let's call this situation a "liquidity quotation." The market has settled down since April as a result of the replenishment of liquidity by governments and central banks.

However, if the economic stagnation due to the corona crisis is prolonged, many troubled companies will face the problem of solvency instead of liquidity. A short-term slump may be addressed by injecting liquidity. But if it continues for a long time, whether those companies could survive will be questioned. When the problem of solvency comes to the fore, even bold policy measures by governments and central banks could not maintain strong financial markets.

I have already mentioned that if interest rates rise, the current stifling situation of low interest rates, low growth, and low inflation may disappear. Another thing to note is the disappearance of the disparity between financial markets and the real economy. If the real economy recovers and approaches the firmness of financial markets, there will be no problem. If, however, the real economy remains weak for a long time, there is fear that financial markets will crumble.


Amid the corona crisis, many countries are simultaneously increasing their fiscal expenditures and expanding monetary easing. With little prospect of the end of COVID-19, there is a growing concern that the economic downturn will last longer than initially expected. Nonetheless, financial markets remain strong at variance with the real economy. Although these policy measures need to be implemented in the face of the corona crisis, the subsequent macroeconomic development will however undoubtedly be affected crucially by the large-scale macroeconomic policy measures.

The deflationary situation of low interest rates, low growth, and low inflation; the mounting public debt; and the favorable stock market at variance with the weak real economy --- these have, as mentioned earlier, been observed since the time before the corona crisis. However, unprecedented fiscal spending and monetary easing in response to the corona crisis undoubtedly help to intensify uncertainty about whether these trends will continue into the future.

At the time of the Great Depression, the economic downturn lasted for a long time in a vicious cycle of the macroeconomic downturn and wrong economic policies. We should not repeat similar mistakes. First, we should exhaust every possible measure to stop the spread of virus infections as soon as possible. At the same time, we should keep a watchful eye on subsequent changes in finance and in the global economy and take correct policy measures.

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