Coronavirus crisis justifies more government spending, former bank governor says

Without a big economic package and increased spending, the effect of the pandemic on the economy will be ‘even more devastating’, IDI’s Karnit Flug says

Shoshanna Solomon is The Times of Israel's Startups and Business reporter

Governor of the Bank of Israel Karnit Flug during a meeting of the Finance Committee in the Knesset in Jerusalem on January 06, 2014. (Photo credit: Flash90)
Governor of the Bank of Israel Karnit Flug during a meeting of the Finance Committee in the Knesset in Jerusalem on January 06, 2014. (Photo credit: Flash90)

The coronavirus pandemic will inevitably drag economies into a recession — and the stronger the health and social distancing measures imposed to contain the virus, the stronger the economic recession will be, a former governor of the Bank of Israel warned on Sunday.

“The outbreak of the pandemic together with the measures taken by governments around the world to contain the spread are quickly dragging the world economy into a recession,” Karnit Flug, former governor of the Bank of Israel and a VP for Research at the Israel Democracy Institute, said in a videoconference. “It seems that a recession is inevitable. However, its depth and duration are still unknown.”

The efforts made worldwide to keep the pandemic curve flat — in a bid to cap the number of people getting infected and needing the already-strained hospital services — are, however, the same steps that are steepening the recession curve, she said.

“A flatter epidemic curve, or healthcare curve, implies a deeper recession,” she said.

The Magen David Adom national emergency service drive through test complex in Ashdod on April 1, 2020 (Flash90)

Flug added that the pandemic has affected both the supply and demand sides of economies globally, as travel shutdowns and restrictions placed on businesses and people curb production and consumption.

In March, the Finance Ministry announced an economic rescue package worth NIS 80 billion (approximately $22 billion), the largest in Israeli history, while the Bank of Israel said it would buy NIS 50 billion in government bonds on the open market to ease credit conditions and bolster the economy amid the coronavirus crisis.

Flug said that the fiscal and monetary measures implemented by the government and the Bank of Israel are more or less in line or just below what other countries globally are implementing, and are “a step in the right direction.” These policies have been set up in a rush, she said, as things develop on the ground. The key will be to make sure they are implemented in full and any flaws found in the measures are corrected as they show up.

The system “must be flexible enough to fix it along the way,” she said.

Lost economic output in Israel, Flug said, is estimated to be between 3.5% of GDP and as much as 9% of GDP, depending on when the restrictions are lifted — by the end of April or the end of May.

Asked about the long-term implications of the massive spending on Israel’s budget deficit and government debt, Flug said increased spending at this time is justified to ward off even more devastating consequences.

“At the moment, it is very important to actually take all the measures in order to reduce the long-term damage to the economy, as a result of this lockdown,” she said. “Yes, it means higher deficit and higher debt, and yes it means we will have to finance it over time, over the years. But if we don’t take this measure, the effect on the economy will be even more devastating. And I think the cost of that will be huge.”

Governments around the world have “learned from past experiences,” she added, and even those that are generally reluctant to increase spending have allocated enormous sums.

“Not taking these measures will actually make this short term event into a much longer and deeper recession,” she said.

Flug said she is not sure whether Israel’s central bank will follow the cue of other central banks and lower interest rates at the end of this month. The Bank of Israel’s key lending rate, at 0.25%, is “low as is,” she said. And the Bank of Israel has already taken “very substantial measures to provide liquidity” by purchasing a substantial amount of government bonds. “It took the measures necessary, under the circumstances.”

Israel entered the coronavirus crisis with record low unemployment rates, growth, a current account  surplus, “relatively low” public debt and “very solid banks” that accumulated a lot of capital and liquidity to now provide credit to those in need, she said.

So, from a macroeconomic standpoint, Israel’s economy in general was in very good shape, which makes it “somewhat easier” to deal with some elements of the shocks generated by the coronavirus, Flug said.

Even so, she added, the shocks created by the virus are “very, very difficult to deal with.” These include record high unemployment levels posted in Israel at some 24%, from a record low of 3.6%.

read more: