Since the outbreak of the crisis, both national and European policy makers have adopted expansionary fiscal and monetary policy stance to help ease pressure and inject liquidity into the economy. National governments and the European Central Bank focus on different objectives: fiscal policy makers aim to address the harm on businesses and workers from losing their jobs by exercising their powers of taxation and spending while monetary policy makers aim to ensure that there is ample liquidity and market stabilisation in the euro area by adjusting the interest rates to affect money supply and make use of open market operations to inject liquidity into the market.
Economic recovery will depend on the right combination of monetary policy and effective fiscal and regulatory policy, both at national and European level. Decisive and coordinated action is key to providing stability to the global economy and financial markets, boosting confidence, and preventing deep and prolonged economic effects.
The ECB has adopted measures to support demand and confidence by easing financial conditions, lowering borrowing costs for households and firms, and also inject liquidity into the market. On the other hand, national governments have adopted measures to support the most affected by providing wage subsidies for businesses affected by shutdowns to help prevent bankruptcies and massive layoffs that will have lasting effects for future recovery. Moreover, financial support for lowincome households was also provided to support consumption and preserve minimum living standards.
The gravity of the consequences of this outbreak is still highly uncertain. Many people have now accepted that the virus will continue for some time, and even though some restrictive measures will be loosened in the coming days, it will take some time before we gradually go back to our normal way of living.
As from May 4, a number of commercial establishments were allowed to reopen with a number of mandatory conditions that must be followed. Moreover, the number of persons that are allowed to gather in public spaces has increased to four persons. The order that prohibited non-essential travel between Malta and Gozo has also been revoked. Additionally, the order to close Vehicles Roadworthiness Testing Stations has been revoked and the Court registry has been removed from the order of the closure of the Courts of Justice with effect from 4 May 2020. All other restrictions are to remain in place until further notice. The goal is to reopen all business by end of May.
As the number of active cases gradually decreases, national governments have to plan a strategy to exit from the enhanced support that was given in response to the crisis. The reaction to the crisis was to provide lax fiscal incentives however such measures cannot be permanent. As of today, there is not enough information to precisely decide which exit path will be optimal from the perspective of tomorrow. However, a set of criteria must be developed to guide the unwinding of the support measures when the situation returns to normal and the rationale for the measures fades away.
In theory, designing an optimal exit strategy should not be too difficult. In an ideal world, fiscal policy should be tightened before monetary policy in order to ensure that public debt remains sustainable and that monetary policy is not overburdened.
However, as we all know, first-best solutions are often hard to implement in reality because they are based on unrealistic assumptions relating mainly to the ability of policy-makers to make rapid decisions and to change them if needed. In reality, fiscal policy is normally decided once a year through the budget process, but is not implemented until the following year. This process makes decision-making rather inflexible and less likely that fiscal policy can exit before monetary policy, which is typically a much more flexible instrument.
The timing of the decision to exit is somewhat important, as it should neither be too early nor tardy. If the exit decision is made too early, the economic recovery may be put at risk, as it might produce a tightening effect on consumption and investment decisions at the very time when the pick-up in the economy is still fragile. This might hence lead to bankruptcies and in turn layoffs, which could aggravate the economic conditions. Furthermore, it might further restrict credit conditions while the banking system is still restructuring its balance sheet.
On the other hand, a late tightening means that fiscal and monetary conditions will remain too lax for too long, sowing the seeds of the next crisis. Expanding too much can cause side effects such as high inflation or an overheated economy by increasing aggregate demand above the optimal level. Moreover, it will overburden national debt and could ultimately lead to a budget deficit.
Past crises confirm that not only is the timing of the exit crucial, but also its communication to market participants. The impact of reversing lax fiscal and monetary stimuli depends on whether they have fully anticipated it.
During the first quarter of 2020, government deficit increased by €178.3 million when compared to the same period last year. This increase was driven by the adoption of an expansionary fiscal policy in response to the outbreak: an increase in total expenditure of circa 8% and a reduction in recurrent revenue of circa 9%. By the end of March, national debt stood at €5.5 billion, a €47.8 million increase.
Whether we return to the situation before the crisis or whether there will be a permanent effect is still uncertain.
