Harvard professor Carmen Reinhart '78 discusses global economic crisis

FIU alumna and Harvard professor Carmen Reinhart '78 recently spoke to economics professor Mihaela Pintea and her class about the global economic disruption brought on by the COVID-19 pandemic.

“I think the bottom line is that when this is all said and done, the size of the U.S. government will be much bigger,” said Reinhart in response to being asked whether there may be an influx of social programs similar to those of Franklin D. Roosevelt’s New Deal.

Asked whether the economic repercussions of the pandemic will be as drastic as those post-Depression, Reinhart said there are definite similarities.

"This crisis is worrisomely similar to the global picture of the Great Depression of the 1930s," she said. "I'm not saying we are going there, but there are worrisome similarities."

A portion of Pintea's Q&A with Reinhart follows below.

Mihaela Pintea:We are in the midst of a global crisis, with major disruptions to the world economy brought about by the coronavirus pandemic. Things are still evolving rapidly. How would you compare this crisis to previous crises that you studied?

Carmen Reinhart: I feel that this crisis, this time truly is different and let me explain what I mean by that. There are parts that are going to be completely different, unprecedented for which I'm not aware of useful historical examples and there are parts for which the historical examples will be very useful.

This crisis did not start out as many financial crises do with a surge in bad lending. It started with a real supply shock: the coronavirus. This crisis did not start out because of imprudent lending by banks for a housing boom where you had a bubble. It didn't start with finance.

The global coronavirus pandemic is a shock that affected banks that had made what were good loans or seemed like plausible loans to individuals and to businesses. However, due to the coronavirus, all of a sudden businesses have closed their doors, households have lost access to income and unemployment numbers are beyond appalling.

The policy response of the economies of basically saying look we really value human lives: the response is to really shut down and try to first contain the virus in order to slow down the spread of disease. That's completely opposite from the last major pandemic, which was the influenza epidemic of 1917-1918. The major reason why it was completely different is because the 1918 pandemic, the Spanish influenza was during World War I, so the idea that you were going to shut down an economy and have people stay at home and have production come to a standstill just doesn't operate in a wartime economy and it certainly didn't operate in those days.

The year in which the United States deaths due to the pandemic peaked at 675,000 deaths in 1918, which were the highest death rates, real GDP in the United States grew 9 percent. Business failures practically went down to an all-time low. That's completely different from anything we are going to see now because the policy response was entirely different.

This crisis started as a health crisis, a pandemic but it is morphing into a financial crisis and financial crises are characterized by recessions, recessions that are deep, recessions that are longer than the normal recession. They are also characterized by defaults: households can default on mortgages, firms default on their loans country, sovereigns default on their debts. 

As some counterexample, the 2008-2009 global financial crisis was really not that global. It hit emerging markets and pretty much everyone in late 2008 early 2009, but the emerging markets led by China had a very rapid recovery.

This environment that we are in is really impacting everyone because we don't know to what extent the coronavirus issues will worsen in Central and South America and Africa, in other parts of Asia that haven't been as affected yet. The global reach of the crisis is there, so that is one similarity.

Another thing that is similar to the 30s is a crash in global trade and the breakdown of global supply chains. Right now, we all know that the airline industry is paralyzed nobody is traveling, but that also applies to maritime trade (e.g. you have Chilean fruit exported to China rotting into the docks because there are health issues in loading and unloading), and the sheer impact on global trade is very worrisome.

MP:Should we be expecting more countries to default on their debts?

CR:  Yes, I am especially worried about Ecuador. They live and die really with the price of oil, oil prices right now in the $20s per barrel are less than half of what they budgeted in their fiscal accounts, so they are having major revenue shortfalls. At the same time, they are the second country in Latin America, after Brazil, in terms of cases of coronavirus. They are a fully dollarized economy and thus they can't really do much with monetary policy.

How about the countries that depend fully on tourism, such as the Caribbean islands, or places that are less so, but still very dependent on tourism (e.g. Thailand). All these countries are experiencing very difficult hits. I'm not suggesting Thailand is going to default. Thailand doesn't have that much external debt, but I do think Ecuador will and I think many others will, too.

The critical factor in my view, the critical factor for which I don't know the answer is how long this crisis is going to last, because the longer it lasts the greater the strain on what are already strained budgets. Notwithstanding the large-scale stimulus that we are getting on the fiscal and the monetary side, which I think is all perfectly appropriate, I'm very confident that the longer a shutdown continues at the national level, and the global level the more the economic damage and the more likelihood we will see more defaults.  

MP:What do you think the economy will look like in terms of employment as we recover from this crisis? And how long might that recovery take?

CR: We don't know how long it will last, but we know for sure that in terms of v-shaped, in terms of the sheer downward impact of this slide, the global financial crisis is going to look like a piece of cake. I have no idea what the second half of this year is going to like, but I can tell you that the stuff that's shaping up for the first half—whether it's the impact on China, the numbers we are already seeing for the U.S. and for Europe are really abysmal.

I don't think there are many in the economics profession, although more in the health profession that can say how successful the quarantine measures are. There are hopeful signs for it, for instance from northern Italy that things may be stabilizing, which would be more like a pattern of what we saw in China if you believe the numbers that they've leveled off. I'm not skirting around your question it's just that I don't know how quickly the risk of contagion will be effectively dealt with, and I keep saying this: the longer this goes on the more bankruptcies, the deeper the recession, the bigger the job losses. The duration is important.

MP:There has been some discussion, as you mentioned, that the current health crisis is morphing into a financial crisis. If the economy contracts to similar levels (to the Great Depression), do you see a larger appetite for more social programs, such as Medicare for All? What other social programs do you see taking center stage?

CR:  I think the bottom line is that when this is all said and done, the size of the U.S. government will be much bigger. It will be much bigger because there will be big interventions. Already the fiscal stimulus is on a scale that, outside of the world wars, we haven't seen anything like this. I don't know what shape the health programs are going to be, what shape the safety net will take, but I think that in the aftermath of Covid-19, we are going to have a bigger government as a legacy.

You are not going to get as dramatic a change as the New Deal era and the 1930s, but I think it is going to definitely move in the direction of a bigger government role in health, a bigger government role into safety nets and so on and a lot of the things that we have seen on more mature economies like Europe.

MP:How should countries prioritize spending during this crisis?

CR: If you really don't have the resources and you are fiscally constrained, your revenues have plummeted  as tourism, manufacturing, commodity prices have plummeted. So if you are in that kind of emergency environment and have very limited resources, do you want to devote those resources to fight Covid-19 and deal with the health emergency? Or do you want to repay your foreign creditors?

This is a global emergency and this is not saying you are not honoring your debts and you may have to deal with those creditors at a later stage, but that temporary moratorium is an appropriate response to deal with those in need.

MP:  How about at the domestic level and the $2 trillion dollar fiscal stimulus that was passed?

CR: The issue that I mentioned of debt moratorium is also very much applicable at the nitty-gritty local level. People don't have incomes, so repaying mortgages, repaying credit cards, repaying any kind of debt is problematic. I suggest moratorium on debt payments. We have had our incomes suspended so the commensurate step is to suspend payment on that by deciding the stimulus package, which is very substantive. But remember: it is not just about households, but also about corporations.

People tend to view corporate bailouts in a negative manner, but the businesses are the one that hire people. The fiscal stimulus also includes medium and small businesses, i.e. you had a restaurant or a small store that was working well and now your revenue has gone down to zero. So that's a business, but those people [who] the restaurant was hiring are impacted by that shutdown. The issue of the debt moratorium applies to households. It applies to businesses. It applies to sovereign nations.