MNI INTERVIEW: Jackson Hole Author Urges US to Save Firms

The U.S. economy will reap the benefits of staving off pandemic-driven corporate bankruptcies for far longer than Covid-19 lasts, and policy makers should pledge bold action to maintain long-term confidence in the economy, the author of a paper presented at the Fed's Jackson Hole conference Thursday told MNI.

Akin to ECB chief Mario Draghi's pledge to do whatever it takes to stave off the banking crisis, policy makers must try to prevent a wave of demoralizing corporate bankruptcies while also quickly moving workers whose jobs vanish into higher-growth industries, Laura Veldkamp of Columbia University said in an interview.

"Those are kinds of things we have in the toolkit, but we need to turbocharge right now, and see this as a period of big adjustment," she said.

The ongoing crisis will have "large, persistent adverse effects on the U.S. economy, far greater than the immediate consequences," according to the paper jointly authored with Julian Kozlowski of the St. Louis Fed, Veldkamp and Venky Venkateswaran of New York University. "Preventing bankruptcies or permanent separation of labor and capital, could have enormous consequences for the value generated by the U.S. economy for decades to come."

The paper, which also finds that the surge in demand for safe assets could drive down long-run "natural" rate of interest by 67bps, underscores earlier comments by Chair Jay Powell that the potential for scarring could add an extra challenge to the Fed's dual mandate of full employment and price stability, and that extraordinary fiscal and monetary interventions are needed.

Scarring Body and Mind

Their paper, "Scarring Body and Mind: The Long-Term Belief-Scarring Effects of COVID-19," ran simulations that added a longer memory of an extreme event like a pandemic. That approach contrasts with "rational expectations" models suggesting a rapid recovery as people accurately predict the odds of another disaster.

"Our point is not to make a forecast of the coming year's events but that that whatever you think will happen over the next year, the ultimate costs of this pandemic are much larger than your short-run calculations suggest."

"This could come from the lost value of cruise ships that will never sail again, businesses that do not reopen, loss of customer capital or just less intensive use of commercial space due to a persistent preference for more distance between other diners, travelers, spectators or shoppers. It could also represent permanent changes in health and safety regulations that make transactions safer, but less efficient," the authors wrote. "While the short-run gains from limiting bankruptcies is well-understood, our analysis shows that neglecting the effect on beliefs leads one to drastically underestimate the benefits of such policies."

Happy Middle Ground

Veldkamp gave an example of how costly it would be to see Manhattan's restaurants mostly go bankrupt and re-open later after spending money on renovations and re-hiring to do essentially the same business. Finding ways to save viable companies is important both for efficiency and fairness.

"Some of it is going to be inefficient, but it will help to remedy belief scarring. If we let everybody go bankrupt, we will get the fastest possible transition, but my gosh, will it be bloody and people will be scared and terrified of investing for years to come," she said. "We have to find a happy middle ground."

The harsher impact of the pandemic on households and small firms suggests that consumer confidence or smallcap stock indexes are a better gauge of the recovery than say the S&P 500, she said. "The pain is being felt by small businesses and households that have members that are working for smaller firms, and out traditional indicators don't pick those up as well," she said. "Consumer confidence matters more than ever before."