Common sense foundations behind rapid market recovery

Speed of rally in stocks is breathtaking but causes are strikingly simple

Robin Wigglesworth

US stocks have led the market recovery, with the S&P 500 last week touching a record high © AFP/Getty Images

The hottest finance industry topic is the extraordinary market recovery from the Covid-19 shock, what is causing it, whether it is durable, and what the consequences are.

It is worth taking a moment to marvel at just how powerful the rally has been. Global equities have already clawed back almost all the losses suffered in one of the biggest and certainly the swiftest collapses on record, and earlier this month went back into positive territory for the year. 

US stocks have been the stars of the show, with the S&P 500 last week touching a new record high, despite unemployment still being near post-second world war peaks. Contrast this to the four years it took for equities to recover from the global financial crisis of 2008. 

The aggressive response of central banks is often credited for the strength of the rally. Add to that a robust fiscal response by governments, and the so far largely successful end of lockdowns in many leading economies, and you had the ingredients for a strong recovery, especially in the US, where the market is dominated by a handful of technology behemoths that benefit from the Covid-19 disruptions. 

But these factors are only part of the equation and cannot entirely explain just how far and fast markets have rallied. To understand this, we need to look at the biggest, least-appreciated change from a decade ago: Investor expectations. 

When the financial system stabilised in 2009, the debate was largely around when interest rates would be “normalised” and bond yields would climb back to pre-crisis levels. Some thought it might take a year or two, while others reckoned “lower for longer” was the most likely scenario. Any disagreement was largely around timing. 

Line chart of 10-year, 10-year Treasury forward rate showing The most important chart in the world?

Today, the “lower for longer” view has morphed into “low forever”. A decade ago, betting against bonds was almost fashionable. Today, the trendy trade is to bet on yields never rising again. Some investors now think above-inflation Treasury yields is something they will wistfully tell their incredulous grandchildren about. 

The best evidence is the 10-year, 10-year Treasury forward, a futures contract that shows what investors think the 10-year Treasury yield will be in a decade’s time. It provides a distilled, clean(ish) measure of investors’ long-term expectations for the world’s most influential interest rate.

In 2009, the 10-year, 10-year forward yield rose from 3 per cent to north of 5 per cent, as investors bet on prices falling in a great “normalisation”. From 2010, it haltingly ground lower again. But this year the 10y10y measure has collapsed to just 1.6 per cent. In other words, investors expect Treasury yields to remain well below the Federal Reserve’s inflation target for at least the next decade — and likely longer.

The new thesis can also be seen in bank stocks, which typically benefit from rising interest rates. Back in 2009, bank stocks recovered more quickly than the broader equity market, as investors bet that survivors would grow stronger from the calamity and emergency stimulus would eventually end. Warren Buffett, in particular, made a fortune from big, daring wagers on financial stocks in the depths of the crisis.

In sharp contrast, banks have lagged far behind this year’s stock market rally and the “Oracle of Omaha” is now dumping bank stakes rather than amassing them. 

The decline in long-term interest rate expectations does not explain everything, of course.

Japanese bond yields have been similarly depressed for years without any meaningful impact on equity valuations there. And it is inherently risky to make long-term investment decisions based on an indicator that has proven faulty in the past. 

Line chart of Normalised as of January 1, 2020. showing Bank stocks have lagged badly behind the market recovery

After all, exactly a decade ago, the futures contract suggested that the 10-year Treasury yield would be 4.5 per cent today. Instead, it is 0.6 per cent. Investors could obviously be wrong again, albeit the other way around this time. The strength of the current “low forever” consensus does feel a tad overdone and it will surely be tempting for some contrarian investors to take the other side at some point. 

However, for the foreseeable future it is hard to envisage high-grade bond yields moving meaningfully higher. The secular, broad-based decline in economic vigour and the weight of global debt means that any serious increase in yields would likely be countered by even more central bank stimulus. 

That has huge consequences for the entire finance industry, whether pension funds desperate to know where they can eke out returns, or banks dourly looking at their loan books. And when investors are in practice anticipating that money will in real, inflation-adjusted terms be free for at least the next decade, what would be considered a fair price for all other financial assets inevitably has to be revisited.

Perhaps the other topic for those oddly financially-savvy grandchildren will be why equities were ever so cheap.

Free Exchange

America’s fiscal federalism is less superior than you might think

Europe’s federation has been surprisingly effective

Quick: would you rather face the worst economic crisis in history as a resident of America’s fiscal union, or Europe’s?

An easy choice, surely; a decade ago, the euro area’s skeletal economic institutions turned an American-made panic into a near-collapse of the European project. By 2013 euro-zone output was 3% below its peak in 2008, whereas America’s was nearly 5% higher.

Look again, though, and the answer is less obvious.

Both fiscal federations have flaws. But the covid-19 crisis shows that Europe may not be so badly outclassed by America’s fiscal union after all.

The division of the power to tax and spend across many layers of government—fiscal federalism—has many potential benefits. Decentralisation allows governments to satisfy a diverse population’s policy preferences and cope with regional needs.

Given free movement of labour and capital within a federation, competition between regional governments can lead to policy innovation and limit state overreach.

At the same time, membership of a federal entity brings scale economies: access to more resources and a bigger market; more effective risk-sharing. Economists reckon that the task of macroeconomic stabilisation is best left to the highest level of government.

It has a greater capacity to manage local shocks: as federal-tax receipts in one region fall, revenue is cushioned by those from elsewhere. For a federal authority, the spillover of fiscal easing across state borders is not a problem. A shared currency, too, should be complemented by fiscal powers.

A strong federal budget, though, creates the risk of moral hazard. The lower levels of government may borrow too much, counting on federal bail-outs when things go wrong.

Effective fiscal federalism thus requires a mechanism to constrain states’ borrowing. America confronted this problem in the 19th century. After fiscal integration led to reckless state borrowing and defaults, state governments adopted balanced-budget rules.

All except Vermont are bound by them, leaving countercyclical policy the prerogative of the federal government. In downturns, states depend on federal relief: in the form of reduced federal-tax payments, increased welfare spending, and occasional discretionary stimulus (like the $1,200 cheques posted to most Americans earlier this year).

No real-world federal system meets the ideal. The euro area, on the eve of the financial crisis in 2007-09, suffered from dangerous defects.

Monetary power rested with the supranational European Central Bank (ECB). But member states retained near-total control over crucial policy levers, like the power to tax and spend, and to regulate banks.

The crisis exposed these weaknesses. Unsure that the ECB would act as lender of last resort to troubled member states, investors shunned vulnerable governments, sending bond yields soaring and raising the spectre of chaotic exits from the eu.

The predicament contrasted starkly with events in America, where a fiscally powerful central government backed by a proactive central bank stood ready to help hard-hit states and troubled banks. Many economists urged the euro area to replicate two centuries’ worth of American-style fiscal integration.

Instead the zone did just enough to survive. A promise by the ECB to defend the single currency persuaded bond vigilantes to retreat.

Even as it limped out of crisis, Europe seemed to sow the seeds of future troubles. As its crisis abated, the euro area moved to minimise moral hazard. Limits on government borrowing agreed in the late 1990s were strengthened post-crisis: through the introduction of closer monitoring and punitive sanctions, for instance.

But these efforts were not matched by complementary, American-style mechanisms to provide collective stimulus. The oversight seemed designed to leave the European project vulnerable, once again, in the face of any new recession.

Yet for all its missteps, Europe’s fiscal performance compares surprisingly well with America’s. Government spending contributed positively to euro-area growth in every year except 2011, when its effect was neutral, and 2012, when governments’ budgets reduced growth by just 0.1 percentage points. Austerity did concentrate economic pain in parts of the periphery.

But that was also the case in American states, where balanced-budget rules led states to make deep spending cuts. Indeed, these were so large that the federal largesse intended to keep America’s overall fiscal position stimulative barely managed to offset the cuts.

Government spending at all levels contributed 0.7 percentage points to growth in 2009, but was neutral in 2010 and subtracted 0.7 percentage points from growth in 2011—even as the federal government provided roughly half a trillion dollars in aid to states that year.

Just you wait

The response to covid-19’s economic devastation looks similar. On the surface, the staggering stimulus package enacted in America in the spring, worth about 13% of GDP, looks a far more potent contribution than the EU’s fiscal package, agreed in July. That recovery fund, supported by collective borrowing, will spend nearly 5% of eu GDP over several years.

But America’s stimulus is largely exhausted, and its dysfunctional Congress has been unable so far to pass additional measures. Cuts to state and local governments are already weighing on the economy, subtracting 0.4 percentage points from the (annualised) growth rate in the second quarter.

The euro area, by contrast, agreed that fiscal rules should not apply during the pandemic, allowing members to provide economic support on a par with America’s federal response.

No one will mistake the euro area for an exemplar of federalism. Some member states, such as Italy, Spain and even France, will exit the crisis with huge public-debt burdens. The suspension of borrowing rules could deepen anxiety about moral hazard, and lingering hardships could yet trigger a crisis that threatens the entire European project.

But conventional wisdom could use some revision. American fiscal federalism, so often cited as a model for the euro area, looks ever less clearly the superior system.

New Thinking on Covid Lockdowns: They’re Overly Blunt and Costly

Blanket business shutdowns—which the U.S. never tried before this pandemic—led to a deep recession. Economists and health experts say there may be a better way.

By Greg Ip

In response to the novel and deadly coronavirus, many governments deployed draconian tactics never used in modern times: severe and broad restrictions on daily activity that helped send the world into its deepest peacetime slump since the Great Depression.

The equivalent of 400 million jobs have been lost world-wide, 13 million in the U.S. alone. Global output is on track to fall 5% this year, far worse than during the financial crisis, according to the International Monetary Fund.

Despite this steep price, few policy makers felt they had a choice, seeing the economic crisis as a side effect of the health crisis. They ordered nonessential businesses closed and told people to stay home, all without the extensive analysis of benefits and risks that usually precedes a new medical treatment.

There wasn’t time to gather that sort of evidence: Faced with a poorly understood and rapidly spreading pathogen, they prioritized saving lives.

Five months later, the evidence suggests lockdowns were an overly blunt and economically costly tool. They are politically difficult to keep in place for long enough to stamp out the virus.

The evidence also points to alternative strategies that could slow the spread of the epidemic at much less cost. As cases flare up throughout the U.S., some experts are urging policy makers to pursue these more targeted restrictions and interventions rather than another crippling round of lockdowns.

“We’re on the cusp of an economic catastrophe,” said James Stock, a Harvard University economist who, with Harvard epidemiologist Michael Mina and others, is modeling how to avoid a surge in deaths without a deeply damaging lockdown. “We can avoid the worst of that catastrophe by being disciplined,” Mr. Stock said.


The economic pain from pandemics mostly comes not from sick people but from healthy people trying not to get sick: consumers and workers who stay home, and businesses that rearrange or suspend production. A lot of this is voluntary, so some economic hit is inevitable whether or not governments impose restrictions.

Disentangling voluntary and government-ordered effects is hard. One study, by economists Austan Goolsbee and Chad Syverson at the University of Chicago, says government restrictions account for just 12% of the decline in consumer mobility in the U.S.; another, by a team led by economists Kosali Simon at Indiana University and Bruce Weinberg at Ohio State, says they account for 60% of the loss of employment.

Still, because of the close connection between the pandemic and economic activity, many epidemiologists and economists say the economy can’t recover while the virus is out of control.

“The virus is going to determine when we can safely reopen,” Anthony Fauci, director of the National Institute of Allergy and Infectious Diseases, said in April. The Federal Reserve said in late July that “the path of the economy will depend significantly on the course of the virus.”

Such statements leave wide open what represents an acceptable level of infection, which in turn determines what restrictions to impose. If the only acceptable level of infection were zero, lockdowns would have to be severe and potentially indefinite, or at least until an effective vaccine or treatment comes along. Most countries have rejected that course.

Prior to Covid-19, lockdowns weren’t part of the standard epidemic tool kit, which was primarily designed with flu in mind.

During the 1918-1919 flu pandemic, some American cities closed schools, churches and theaters, banned large gatherings and funerals and restricted store hours. But none imposed stay-at-home orders or closed all nonessential businesses. No such measures were imposed during the 1957 flu pandemic, the next-deadliest one; even schools stayed open.

Lockdowns weren’t part of the contemporary playbook, either. Canada’s pandemic guidelines concluded that restrictions on movement were “impractical, if not impossible.” The U.S. Centers for Disease Control and Prevention, in its 2017 community mitigation guidelines for pandemic flu, didn’t recommend stay-at-home orders or closing nonessential businesses even for a flu as severe as the one a century ago.

So when China locked down Wuhan and surrounding Hubei province in January, and Italy imposed blanket stay-at-home orders in March, many epidemiologists elsewhere thought the steps were unnecessarily harmful and potentially ineffective.

By late March, they had changed their minds. The sight of hospitals in Italy overwhelmed with dying patients shocked people in other countries. Covid-19 was much deadlier than flu, it was able to spread asymptomatically, and it had no vaccine or effective therapy.

Taiwan, South Korea and Hong Kong set early examples of how to stop Covid-19 without lockdowns. Their reflexes trained by SARS in 2003, MERS and avian flu, they quickly cut travel to China, introduced widespread testing to isolate the infected and traced contacts. Their populations quickly donned face masks.

Diners in Stockholm on March 27. Unlike many countries, Sweden never imposed a lockdown.

Sweden took a different approach. Instead of lockdowns, it imposed only modest restrictions to keep cases at levels its hospitals could handle.

Sweden has suffered more deaths per capita than neighboring Denmark but fewer than Britain, and it has paid less of an economic price than either, according to JPMorgan Chase & Co.

Sweden’s current infection and death rates are as low as the rest of Europe’s, suggesting to some experts the country may be close to herd immunity. That is the point at which enough of the population is immune, due to prior exposure or vaccination, so that person-to-person transmission declines and the epidemic dies out.

By March, it was too late for the U.S. to emulate the test-and-trace strategy of east Asia. The CDC had botched the initial development and distribution of tests, and limited testing capacity meant countless infections went undetected for months. President Trump continued to downplay testing, and even today the U.S. conducts fewer than 20 tests for every confirmed case, compared with more than 500 in Taiwan and South Korea at their peaks.

The Swedish strategy was also taken off the table. Britain ditched it in mid-March after a team of experts from London’s Imperial College predicted that in the absence of social distancing, 81% of the population would eventually be infected, while 510,000 people would die in Britain and 2.2 million in the U.S.

Those estimates may have been high. Many experts think it takes less than 81% of a population to reach herd immunity. Nonetheless, such predictions helped persuade leaders in Britain and the U.S. to lock down.

Yet at the outset, their goals were unclear, a confusion aggravated by the multitude of terms used. Officials sometimes said their goal was “bending” or “flattening the curve,” which originally meant spreading infections over time so the daily peak never overwhelmed hospitals.

At other times they described their aims as “mitigation” or “containment” or “suppression,” often interchangeably.

“There have been few attempts to truly define the goal, and partly it’s because policy makers and epidemiologists haven’t thought well enough about the vocabulary to define what they mean or want,” said Dr. Mina, the Harvard epidemiologist.

A key determinant in an epidemic’s spread is the reproduction number, or “R value”: how many people each infected person goes on to infect. When R is above one, new infections continue until enough of the population has been infected or vaccinated to achieve herd immunity. When R is below one, new infections eventually fall to zero, although imported infections can trigger outbreaks. Dr. Mina said mitigation generally aims for an R of just above one, while suppression aims for an R of below one.

The U.S. never resolved “whether we were going for mitigation or suppression,” said Paul Romer, a Nobel laureate economist. Mitigation, he said, meant accepting hundreds of thousands of additional deaths to achieve herd immunity, which no leaders were willing to embrace. But total suppression of the disease “doesn’t make sense unless you’re going to stick with it as long as it takes.”

Some countries did achieve suppression through lockdowns. China wiped out the epidemic in Hubei province and has suppressed subsequent outbreaks elsewhere, with sweeping quarantine and surveillance methods that are difficult to replicate in Western democracies.

Tokyo commuters like these seen in late April took to wearing masks in large numbers. Widespread use of masks appears to slow the spread of the coronavirus. PHOTO: EUGENE HOSHIKO/ASSOCIATED PRESS

New Zealand imposed one of the most stringent lockdowns for two months. The country—relatively small and geographically isolated—went on to enjoy 102 days without a new case. Nonetheless, an outbreak this month prompted a reimposition of widespread restrictions.

The U.S. for the most part lacked China’s authoritarian bent and New Zealand’s patience. Asked in March if lockdowns would last months, President Trump replied: “I hope it disappears faster than that.” Indeed, at the end of March his health advisers suggested one more month of restrictions would be enough.

In mid-April, his health advisers issued guidelines for when states with lockdowns should reopen, including 14 days of declining cases and the ability to test and trace anyone with flulike symptoms. “The predominant and completely driving element that we put into this was the safety and the health of the American public,” Dr. Fauci told reporters.

But that same day Mr. Trump made it clear his priority was the economy: “A prolonged lockdown combined with a forced economic depression would inflict an immense and wide-ranging toll on public health,” he said. Within weeks he was praising states that had reopened despite not meeting the guidelines and was tweeting “LIBERATE” to supporters protesting lockdowns.

Many Republican governors prioritized their economies, but some Democrats more committed to lockdowns also struggled to stay the course. When California became the first state to issue a stay-at-home order on March 19, its Democratic governor, Gavin Newsom, said the goal was to “bend the curve.”

New Zealand imposed a strict lockdown and went more than 100 days without a new coronavirus case. Above, a closed restaurant in Auckland in March. PHOTO: BRENDON O'HAGAN/BLOOMBERG NEWS

On May 7, he signaled an unusually ambitious goal: Only counties with zero deaths in the past two weeks and no more than one case per 10,000 residents could reopen ahead of schedule—criteria that 95% of the state couldn’t meet, according to the Los Angeles Times.

Mr. Newsom said science and data would dictate when the stay-at-home order was lifted. Economic and social pressures soon intruded, as county leaders pushed him to relax the criteria. On May 18 he did, dropping the no-death requirement and raising the case cutoff to 25 per 100,000.

Counties quickly began opening. A month later, California’s cases began surging again, far surpassing previous highs.

“I wouldn’t say our strategy ever really changed,” said Mark Ghaly, the state’s secretary of health and human services. “We needed to get [infections] low enough to where our systems can handle sick people.”

Dr. Ghaly said “there were conversations” about pursuing total suppression, as New Zealand had done, but that would have required an early, nationwide commitment, which wasn’t possible with very different views across the country. 

The impact of lockdowns on families, the economy and mental health also mattered, he said: “When you see unemployment numbers going through the roof, businesses not just threatened week to week but potentially [never] being open again, you have to take that into account,” said Dr. Ghaly.

Dr. Mina of Harvard said the U.S. at the outset could have chosen to prioritize the economy, as Sweden did, and accept the deaths, or it could have chosen to fully prioritize health by staying locked down until new infections were so low that testing and tracing could control new outbreaks, as some northeastern states such as Rhode Island did.

Most of the U.S. did neither. The result was “a complete disaster. We’re harming the economy, waffling back and forth between what is right, what is wrong with a slow drift of companies closing their doors for good,” Dr. Mina said.

A rally at the Michigan capital of Lansing on May 14 protested Gov. Gretchen Whitmer’s stay-at-home order. Left to right are Katie Huss, her daughter-in-law Renea Knight and her son Kerry Knight. PHOTO: KIMBERLY P MITCHELL/TNS/ZUMA PRESS

The experience of the past five months suggests the need for an alternative: Rather than lockdowns, using only those measures proven to maximize lives saved while minimizing economic and social disruption. “Emphasize the reopening of the highest economic benefit, lowest risk endeavors,” said Dr. Mina.

Social distancing policies, for instance, can take into account widely varying risks by age. The virus is especially deadly for the elderly. Nursing homes account for 0.6% of the population but 45% of Covid fatalities, says the Foundation for Research on Equal Opportunity, a conservative-leaning think tank. Better isolating those residents would have saved many lives at little economic cost, it says.

By contrast, fewer children have died this year from Covid-19 than from flu. And studies in Sweden, where most schools stayed open, and the Netherlands, where they reopened in May, found teachers at no greater risk than the overall population. This suggests reopening schools outside of hot spots, with protective measures, shouldn’t worsen the epidemic, while alleviating the toll on working parents and on children.

If schools don’t reopen until next January, McKinsey & Co. estimates, low-income children will have lost a year of education, which it says translates into 4% lower lifetime earnings.

Research by Dr. Mina and others has shown that “super-spreader” events contribute disproportionately to infections, in particular dense indoor gatherings with talking, singing and shouting, such as at weddings, sporting events, religious services, nightclubs and bars.
Bars and restaurants accounted for 16% of Covid-19 clusters (five or more cases) in Japan; workplaces, just 11%. Bars, restaurants and casinos accounted for 32% of infections traced to multiple-case outbreaks in Louisiana.

Masks may be the most cost-effective intervention of all. Both the World Health Organization and the U.S. Surgeon General discouraged their use for months despite prior CDC guidance that they could limit the spread of flu by preventing the wearer from transmitting the disease.

The German city of Jena in early April ordered residents to wear masks in public places, public transit and at work. Soon afterward, infections came to a halt. Comparing it to similar cities, a study for the IZA Institute of Labor Economics estimated masks reduced the growth of infections by 40% to 60%.

Klaus Wälde, one of the authors, said nationwide mask wearing is helping the German economy return to normal while keeping infections low. Goldman Sachs Group Inc. estimates a universal mask mandate in the U.S. could now save 5% of gross domestic product by substituting for more onerous lockdowns.

Some epidemiologists and economists argue ramped-up testing could enable the economy to reopen safely without a vaccine. Mr. Romer estimates the U.S. could restore $1,000 in economic activity for every $10 spent on tests.

Dr. Mina pointed to a paper-strip test anyone can use to detect the virus in a sample of saliva in minutes. It is less accurate but far faster and cheaper than sending samples to labs, he said. If 50% to 60% of the population in hot spots took such a test every other day, the disease could be suppressed, he said.

Dr. Mina’s and Mr. Stock’s team has designed a “smart” reopening plan based on contact frequency and vulnerability of five demographic groups and 66 economic sectors. It assumes most businesses reopen using industry guidelines on physical distancing, hygiene and working from home; schools reopen; masks are required; and churches, indoor sports venues and bars stay closed.

They estimated in June that this would result in 335,000 fewer U.S. deaths by the end of this year than if all restrictions were immediately lifted. But they say the plan also would leave economic output 10% higher than if a second round of lockdowns were imposed.

“If you use all these measures, it leaves lots of room for the economy to reopen with a very small number of deaths,” Mr. Stock said. “Economic shutdowns are a blunt and very costly tool.”

The U.S. South and Southwest have provided some real-time experiments in targeted lockdowns. Arizona imposed a stay-at-home order in March and rescinded it in early May.

A temporarily closed bar in Tucson at the end of June / PHOTO: CHENEY ORR/BLOOMBERG NEWS

When cases soared, Republican Gov. Douglas Ducey resisted reimposing restrictions or requiring masks. He then eventually allowed cities to require masks, ordered bars, gyms, movie theaters and water parks to close and told restaurants to operate at no more than 50% capacity. Gatherings of more than 50 people were prohibited and masks strongly encouraged. But he didn’t lock down the entire state. Cases and hospitalizations have since fallen sharply to early May levels, or lower.

California, similarly, ordered indoor activities at restaurants, bars, museums, zoos and movie theaters to close in mid-July, but didn’t issue a stay-at-home order, prohibit outdoor activities or suspend elective surgery, as it had in March and April. Cases have begun to drop, while hospitalizations have declined 35% since their July peak.

“In March, people didn’t realize the benefits of mask use,” said Dr. Ghaly, the state’s secretary of health and human services. “The evidence on being outdoors rather than indoors is quite compelling.” Compared to April, “We know so much more.”

—Illustration by Angie Wang

—Graphics by Hanna Sender

Priorities for the COVID-19 Economy

With hopes of a sharp rebound from the pandemic-induced recession quickly fading, policymakers should pause and take stock of what it will take to achieve a sustained recovery. The most urgent policy priorities have been obvious since the beginning, but they will require hard choices and a show of political will.

Joseph E. Stiglitz

stiglitz274_Gav GoulderIn Pictures via Getty Images_coronavirusclimatechangeprotest

NEW YORK – Although it seems like ancient history, it hasn’t been that long since economies around the world began to close down in response to the COVID-19 pandemic. Early in the crisis, most people anticipated a quick V-shaped recovery, on the assumption that the economy merely needed a short timeout. After two months of tender loving care and heaps of money, it would pick up where it left off.

It was an appealing idea. But now it is July, and a V-shaped recovery is probably a fantasy. The post-pandemic economy is likely to be anemic, not just in countries that have failed to manage the pandemic (namely, the United States), but even in those that have acquitted themselves well.

The International Monetary Fund projects that by the end of 2021, the global economy will be barely larger than it was at the end of 2019, and that the US and European economies will still be about 4% smaller.

The current economic outlook can be viewed on two levels. Macroeconomics tells us that spending will fall, owing to households’ and firms’ weakened balance sheets, a rash of bankruptcies that will destroy organizational and informational capital, and strong precautionary behavior induced by uncertainty about the course of the pandemic and the policy responses to it.

At the same time, microeconomics tells us that the virus acts like a tax on activities involving close human contact. As such, it will continue to drive large changes in consumption and production patterns, which in turn will bring about a broader structural transformation.

We know from both economic theory and history that markets alone are ill suited to manage such a transition, especially considering how sudden it has been. There’s no easy way to convert airline employees into Zoom technicians. And even if we could, the sectors that are now expanding are much less labor-intensive and more skill-intensive than the ones they are supplanting.

We also know that broad structural transformations tend to create a traditional Keynesian problem, owing to what economists call the income and substitution effects. Even if non-human-contact sectors are expanding, reflecting improvements in their relative attractiveness, the associated spending increase will be outweighed by the decrease in spending that results from declining incomes in the shrinking sectors.

Moreover, in the case of the pandemic, there will be a third effect: rising inequality. Because machines cannot be infected by the virus, they will look relatively more attractive to employers, particularly in the contracting sectors that use relatively more unskilled labor. And, because low-income people must spend a larger share of their income on basic goods than those at the top, any automation-driven increase in inequality will be contractionary.

On top of these problems, there are two additional reasons for pessimism. First, while monetary policy can help some firms deal with temporary liquidity constraints – as happened during the 2008-09 Great Recession – it cannot fix solvency problems, nor can it stimulate the economy when interest rates are already near zero.

Moreover, in the US and some other countries, “conservative” objections to rising deficits and debt levels will stand in the way of the necessary fiscal stimulus. To be sure, the same people were more than happy to cut taxes for billionaires and corporations in 2017, bail out Wall Street in 2008, and lend a hand to corporate behemoths this year. But it is quite another thing to extend unemployment insurance, health care, and additional support to the most vulnerable.

The short-run priorities have been clear since the beginning of the crisis. Most obviously, the health emergency must be addressed (such as by ensuring adequate supplies of personal protective equipment and hospital capacity), because there can be no economic recovery until the virus is contained.

At the same time, policies to protect the most needy, provide liquidity to prevent unnecessary bankruptcies, and maintain links between workers and their firms are essential to ensuring a quick restart when the time comes.

But even with these obvious essentials on the agenda, there are hard choices to make. We shouldn’t bail out firms – like old-line retailers – that were already in decline before the crisis; to do so would merely create “zombies,” ultimately limiting dynamism and growth. Nor should we bail out firms that were already too indebted to be able to withstand any shock.

The US Federal Reserve’s decision to support the junk-bond market with its asset-purchase program is almost certainly a mistake. Indeed, this is an instance where moral hazard really is a relevant concern; governments should not be protecting firms from their own folly.

Because COVID-19 looks likely to remain with us for the long term, we have time to ensure that our spending reflects our priorities. When the pandemic arrived, American society was riven by racial and economic inequities, declining health standards, and a destructive dependence on fossil fuels.

Now that government spending is being unleashed on a massive scale, the public has a right to demand that companies receiving help contribute to social and racial justice, improved health, and the shift to a greener, more knowledge-based economy.

These values should be reflected not only in how we allocate public money, but also in the conditions that we impose on its recipients.

As my co-authors and I point out in a recent study, well-directed public spending, particularly investments in the green transition, can be timely, labor-intensive (helping to resolve the problem of soaring unemployment), and highly stimulative – delivering far more bang for the buck than, say, tax cuts.

There is no economic reason why countries, including the US, can’t adopt large, sustained recovery programs that will affirm – or move them closer to – the societies they claim to be.

Joseph E. Stiglitz, a Nobel laureate in economics and University Professor at Columbia University, is Chief Economist at the Roosevelt Institute and a former senior vice president and chief economist of the World Bank. His most recent book is People, Power, and Profits: Progressive Capitalism for an Age of Discontent.