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Transcript: Olivier Blanchard speaks with Michael Morell on "Intelligence Matters"

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In this episode of "Intelligence Matters," host Michael Morell speaks with Olivier Blanchard, former chief economist for the International Monetary Fund and Senior Fellow at the Peterson Institute for International Economics. Blanchard and Morell discuss the near- and long-term global economic effects of the COVID-19 pandemic, the policy response from governments, and the prospects for an eventual recovery. Blanchard also explains recent turbulence in global oil markets and the vulnerabilities specific to lower-income economies.  "Intelligence Matters" will dedicate several forthcoming episodes to understanding the fundamentals and national security implications of COVID-19.

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  • Comparable precedents: "I think it's completely unprecedented. Again, what you had is an overnight forced decrease in production of 35%. I cannot think of any episode in history going back centuries or millennia in which something happened at that speed on that magnitude. You clearly have had periods in history when output would decrease by a whole lot. I'm sure during the Black Plague and times like that. But nothing which happened within a few weeks. So no, this is completely unprecedented."
  • Overall economic recovery: "You can flick the switch off very easily. That's what we did. Flicking it on is much, much, much harder. And that's basically what we'll just have to see. I think we're just going to see what happens."
  • On long-term economic effects: "My guess is that we're going to see the contraction of trade. We're going to see shorter supply chains. Probably supply chains closer to home. For example, European firms using Eastern Europe rather than Vietnam."


Olivier, thank you very much for joining us on Intelligence Matters. It is great to have you with us.


It's a pleasure.


So Olivier, this is the fourth episode in a row that we have done on the COVID-19 pandemic. The first was on the virus itself, the second was on the government's policy response with regard to health, the third was on the national security implications, and today with you we're going to do the economics of all of this. So thank you very much.

What I'd like to do is kind of break this into four big pieces, Olivier. The first is the economic impact. The second is policy response by governments. The third is how to think about the eventual recovery, and then the fourth is any thoughts that you might have about the long term economic implications of all of this.

But if we start with the economic impact, maybe the first question is where were the U.S. and the global economies as we were going into this crisis? Were they strong? Were they weakening? How would you characterize where they were as we were going into this in those initial few weeks?

So I think just before the crisis, the feeling in general was that that was more or less smooth sailing. There were no major issues, imbalances on the horizon. Growth was not great because productivity growth is not great. But there was a sense that although the expansion had been lasting for a very long time, and the longest time in post war history, it could continue. There was no reason to think that a recession was coming or anything was coming. So this was really where we were when the virus appeared.

So how would you describe to a non-economist, Olivier, what's happening to our economies from a demand and supply perspective? How would you explain what's going on today?

I think at the basic level, it's relatively easy to explain, which is that for health reasons, we basically had to close about one third of the economy nearly overnight. And that's, in our jargon, a supply shock. You see, suddenly, basically, one third of production had to stop.

What we realized is that stopping one third is a very complicated thing because it has a lot of effects. You close one firm, and then the firm which is buying from that firm is in trouble or the firm which was selling to that firm is in trouble.

And we've seen this over time become bigger and bigger. And why do I choose the one third number? Because now we now have some estimates from some countries which have been on lockdown. And then we can look exactly at what happened there. And this one third number seems to be the right number.

So we've gone through a phase where, in effect, we just closed one third of production. The effect of this was that it was potentially catastrophic for the people who basically don't have funds that they can use to survive while the closing is going on. And same thing for firms.

And therefore, what we have seen is a need to help them. And we'll come back I think to policy a bit later. But what the government has tried to do is limit the effect on the most vulnerable people and firms. So that's what has happened until now.

And now, we are entering the next phase. And this was needed to control the infection rate and get it down a bit. We're now entering the second phase, which is going to last a long time. And we are entering it too early from a health point of view, I think.

There is no disagreement that if we could have lockdown or something close to lockdown for another month, it would be very, very useful. Much easier to control the infection after. But for various reasons which we can come back to, that's not what we're doing.

And therefore, we're now in the phase in which we have to keep infection rate down. And this is an incredibly uncertain phase both because we don't understand still fully the dynamics of the virus, we don't exactly understand the effect of the virus after the lockdown on the virus.

We don't understand what we can do to basically keep the infection rate down. And so I think the most likely outcome, given that we're really starting too early, is that it's going to be very bump. That once in a while, there are going to be increases in infections.

People tell about a second wave. There could be a second wave, could be a third wave. It's going to be a series of bumps in which we may have to go back into lockdown with the same problems again for people who basically don't have the means to survive these lockdowns very long. How long is it going to last? Probably quite a while. Very difficult to say. But if I had to take a guess, I don't think we'll be back to anything like normal before the middle of next year, maybe the end of next year.

So Olivier, in this second phase, is the economy continuing to contract significantly? Or is it more flat? How do you think about that?

No. You can think of what happened as basically, we just went down and then we're, hopefully, to slowly go back maybe not exactly to where we were before the crisis, but you can think of going up slowly. But the pain is still going to be there for a long time.

But yes, in principle from now on, we should expect growth. Given that we've fallen so much, growth should be positive which again, sounds good, but we're starting from a very low level, so there's going to be a lot of pain for a long time.

And then if we have lockdowns, then it could be that again, we drop again, we have to close firms again and we have another decrease in output, in production. The hope is that we can do it relatively smoothly. But I think the reality is it's going to go up on average. But we may have new lockdowns, new decreases in production.

So Olivier, can you explain to folks what just happened in the oil market, why it was possible to buy oil in the future at a negative price?

I'm not sure anybody bought it at that price. But I think it's easy to understand what happens to the price of oil when there's a decrease in demand, which is supply is very inelastic, and suddenly, there is more oil than people and firms can use.

You start storing it in various places. You end up storing it in boats and ships and wherever you can. But at some stage, there is just too much. And the thing you want is just to get rid of it. And so for a very brief period, the price went negative. That's anecdotal.

What's important is that the price is very low and is going to remain very low. Partly because of an enormous decrease in demand. But also because of the incredibly stupid war between the Saudis and the Russians, which has increased supply at a time at which there was a need for reducing supply, not increasing supply.

So Olivier, for a very long time, low oil prices were good for the American economy. And now, all of a sudden, low oil prices are not good for the American economy. What changed?

First, I don't think they are catastrophic because indeed, consumers have more purchasing power. They're still good. But the fact is that now we produce much more oil than we did in the past. And we're basically self-sufficient. In the old days, we would buy the oil from OPEC, from the other countries.

And therefore, when it was cheaper, it was all good. Now, we produce a lot of it through fracking. And the effect is that that sector is being killed. So now, it's not as good a thing for American producers. It's still a good thing for American consumers.

So this fight between the Saudis and the Russians, what do you think motivated both of them?

I have a hard time -- You would know these things better than I, Michael, because I think it's outside of the domain of economics. The sense is that they wanted to get rid of American producers, which they have done. They also have shot themselves in the foot. Russia is a rather diversified economy and can take the hit not easily. Saudi Arabia has a much harder time taking the hit. So from where I stand, I think they shot themselves in the foot.

Yeah. Yeah, for several years, Putin was trying to build a better relationship with the Saudis. He was getting as close to them as he possibly could. He was trying to garner influence there at our expense. And boy, did he just shoot himself in the foot from that perspective as well. So it's interesting.

But the point about oil prices is that this is very much a separate development. And what's much more important, I think, is the decrease in commodity prices, which is happening just because there is less demand in the world. And that affects commodity producers which are typically low-income countries. That's a big issue. That's very much related to the virus. The oil price story is kind of the more complicated one, and the less central one maybe.

Yeah. So that's exactly where I wanted to go next. I wanted to ask you about both emerging markets and what's happening in emerging markets, and then what's happening in lower income economies. If you could break that out, that would be fantastic.

I'm not sure I'm going to break it up, although you have really to go country by country. But it's clear that together, they are in a much worse situation than advanced economies because they have the problem of the virus. It looks as if it's not as bad for reasons I'm not sure we fully understand.

The dynamics of it seem to be less bad in some African countries than they are, say, in advanced economies. But still, they have to deal with the virus. They clearly have a health system which is utterly unable to deal with it. I assume that you discussed it in your previous podcast.

And then on top of this, they have economic shocks that more advanced economies don't have, which is they rely much more on exports as a growth strategy, which is a very smart strategy to have, except when exports just fall, which is what is happening. They rely on remittances. And remittances have dropped a whole lot.

They rely on commodity prices. And again, these have fallen a whole lot. And in addition to this, they are suffering and that's the main issue in the short run, from enormous capital outflows. And so at the time at which they need to (UNINTEL), their fiscal policy requires them to run deficits, the capital that had gone in is going out.

And the numbers are absolutely staggering there. So it's clear that they have in effect, an impossible situation. Again, I'm talking in general, but that's true of so many of them that generalizing is not unacceptable in this case. And so what's going to happen there is that they are going to get some help.

But the size of the help which is needed is so far beyond I think what will come, that we'll see what we call debt restructuring or debt default. And they'll be unable to basically service the debt that they have. They'll have a hard time getting more. And so I expect things to be extremely bad. Again, varying from country to country, but extremely bad is the average.

And how will that debt restructuring and possible debt defaults play back in the developed economies?

That's a very interesting point. I think interestingly, I think that policy makers have been focused on this. But you're right, now the creditors are half, roughly half official. In which case, this will lead to problems on the fiscal side that are probably tractable.

But half of them are private. And some of them will go belly up, almost surely. And so though I don't think that's going to create a financial crisis such as what we saw in 2008, '09, it is going to be an issue. It's coming down the line, not right now. But I'm quite sure it's going to come up as an increasing issue over the next few months.

And Olivier, maybe one final question before we move to the policy response. You've looked at a lot of economic history in your career. And I'm just wondering if you've ever seen anything like this from the perspective of the speed of the decline, the depth of the decline, and the breadth of the decline. Is this unprecedented from your perspective, even throwing the Great Depression in there?

I think it's completely unprecedented. Again, what you had is an overnight forced decrease in production of 35%. I cannot think of any episode in history going back centuries or millennia in which something happened at that speed on that magnitude. You clearly have had periods in history when output would decrease by a whole lot. I'm sure during the Black Plague and times like that. But nothing which happened within a few weeks. So no, this is completely unprecedented.

Okay. Policy response. So can you explain to folks what the governments of developed economies have done from an economic policy perspective?

Right. So let's start with fiscal policy, right? There are basically two main tools, fiscal and monetary policy. So fiscal policy. The first reaction was to spend as much as possible on health in order to basically give whatever hospitals needed and so on, and so on.

But the fiscal policy can only do so much. And in the end, you need the machines, you need the people. And we could increase the machines a bit and the people a bit, but not much. From that point of view now, the issue on the health front is to do everything we can to get tests earlier, to get vaccines earlier, to get drugs which work earlier.

And what's interesting here is that it could be done on a very large scale if the governments were willing to do it. And it would represent numbers which are enormous, potentially tens of billions, maybe even hundreds of billions. But at the macro scale, these are very small numbers.

So there, what the governments should be in the business of doing, and are not really doing right, is basically think of kind of moonshots or going to Mars or things like that. Basically, being willing to spend what sound like enormous amounts of money in order to get the tests to come online a bit faster and so on. That's one.

From a macro point of view, that's not peanuts. It's maybe 1% of GDP. Not enough numbers by macro standards. The second one, which is where the money has been spent, has been, given that you had this decrease in production of, again, about one third, then there was no way to produce more than that. That was a hard constraint.

But the effect on various people in various firms was very different. And there were a number of people and a number of firms which basically don't have the means to go without revenues for a few months or more. And so this is what I call disaster relief. And that's what has been the aim of fiscal policy.

So trying to basically make sure that people who lost their jobs or didn't have anything to do will get enough to live on. That firms which didn't have a whole lot of liquidity could actually survive for a few months. And the governments in those places of the world have put in place various programs, which are unemployment benefits, subsidies to firms, loans to firms and so on.

And that has represented a very large amount of money. The issue there is that it needed to be done very quickly. And we hear this on the news. It's not good if somebody who's unemployed receives their first check three months later. It's too late. So there was a tradeoff between speed and targeting, if you want.

You would want to give the money to the people and the firms which really needed it. But that would have taken probably months. And it was just out of the question. So these programs in general have been extremely messy and rather inefficient and we hear this again on the radio every day, which is that some people that really need the money are not getting it.

And some people and some firms which really don't need the money are getting it. And I think that was inevitable. It was done badly everywhere. But it was probably done more badly in the U.S. than in Europe. There was an interesting strategy in Europe which was, when the firms had to close or could not operate because there was no demand, to actually keep the workers employed by the firms, technically on unemployment, but still employed by the firms.

The firms paying them and the state paying the firms in order for them to be able to pay the workers. So the workers have stayed very close to the firms. The firms knew who was working for them so they could give the money to the right people.

Where in the U.S., we've gone to a system in which people were laid off, unemployment offices were in charge, and suddenly, they were faced with ten times, 100 times what they usually do and they could not do it. And they had done a bad job.

Same thing with the loans to small and medium size firms in the U.S., where we've asked the SBA, the body in charge of this, to do it. And it's completely unable to do the work. So I think it has been done in a messier way in the U.S. than in Europe.

But in general, the intent has been the right one, which is just let's make sure that people are not going to die and firms are not going to go bankrupt. That's where most of the money has been spent. So this is for fiscal policy. One remark on this is I think the reason why there is so much pressure in the U.S. to reopen comes partly from the fact that the programs haven't worked as well as one could hope for.

And therefore, many people are not getting checks. And they probably know that there is a risk in going back to work and so on. But to them, it's more important than not having the firm. So I think there is some interaction here which explains some of the politics of what we're seeing in the U.S. at this point. And then monetary policy, but yes, go ahead.
Yeah, I just want to ask you one more question on fiscal policy before we move to monetary policy. This difference between the U.S. and Europe, what's at the root of it, do you think? Is it cultural? Is it a different approach to labor markets over a long period of time? Is it good policy making versus bad policy making? How do you think about that fundamental difference?
I think the fundamental difference is obvious. It's a stronger state, a stronger role of the state. The state is much bigger. And in many ways, better organized in Europe than it is in the U.S. The U.S. philosophy has been the private sector is the driver. The state has been underfunded in many margins. Again the (UNINTEL) part of a state is often weak. Europe is stronger in that way. But that reflects a fundamental choice between the private sector and the public sector which is different on both sides of the Atlantic.
Okay, monetary policy.
So monetary policy, in a standard recession in the past, monetary policy would play an important role. But when we got into the crisis, monetary policy had already done a lot. And in many countries, in Europe, for example, the interest rate was already at zero. Right, in the U.S. it was a bit higher, coming back from zero a few years earlier. But it was very low.

So in terms of standard monetary policy, which is when the economy slows down, you decrease the interest rate to kind of push the demand. There was just not a whole lot of room to play. Central banks have done what they could, but that was limited in what they could actually do.

Where monetary policy has been extremely good, extremely aggressive, is in dealing with what I would call the dislocations of financial markets. When you have a shock like this, everything is on the table in terms of how investors are going to behave. So they take money out of some markets because they needed it somewhere else.

And so you get these enormous dislocations. If there is no central bank intervention, you see crazy prices, up, down. The kind of things that we saw for oil, for example, where there is no central bank involved. And then suddenly, some price goes completely crazy, and then some firm goes bankrupt because there was no way to think about what would happen in that case.

So what the central banks have done is basically be on the buying or the selling side of the market, but typically on the buying side. When investors would go out of a market, they would basically go in and try to smooth things, make the market work better.

And that has played a very important role. And they have been extremely aggressive in doing so. So we could have had a financial crisis due to liquidity constraints, that some of the financial institutions needed money and had to do crazy stuff and couldn't get the money. We've avoided this.

Now, later on there is still the issue that we briefly discussed, if there is debt, we start defaulting, for example, in emerging markets. Or if the U.S. economy continues, there are bad shocks again, then we may have potential problems of solvency rather than liquidity. But for the moment, the central banks have done an outstanding job I would say.
So Olivier, there's this discussion, right, between this tradeoff between the economy and health. How do you think about that?
So I think there're actually two debates. One is past. And I think the answer is clear, which is did it make sense to actually use the strategy we use to have a lockdown, rather than to go for what is known as herd immunity, which is letting the virus just do its job and then be done with it.

I think there is no question that it made sense to have a lockdown and try to get the virus under control before moving to the next phase. The few countries which vaguely thought about it changed their mind very quickly. In the U.K., they thought about it. They went this way for a few weeks and then realized it was going to be catastrophic.

So I think that issue is past. There is no question that there was a need for a lockdown. Now, I think the more interesting issue is now, which is that we are on lockdown in many places in the world, and at what point can we relax, can we basically allow economic activity, while keeping the infection rate under control?

And I think that's a much more relevant question. It's not a zero-one question, you do it or you don't. It's how you do it and how closely. And the truth is nobody knows exactly what the tradeoff is. It depends on a lot of factors that we still don't know.

So we'll basically have to try. And what's happening in the world is that every country, every state in the U.S. is trying its own way. My suspicion that some are going to go too fast, probably in the U.S. in particular. But we're just all going to learn.

And there're going to be adjustments along the way. And probably what I've called (UNINTEL) could be worse, which is increasing the infection rate, which forces a new lockdown here and there. The fact that everybody is going at it in different ways is going to create tensions.

We're seeing it between states in the U.S. We're seeing it in Europe with the closing of borders. States which are doing better are going to be reluctant to allow people from other states to come in, and so on. But again, this is something that we have never experienced in any way, shape or form.

And we'll just have to play it slowly. One big issue politically is how governments are going to keep their credibility if they have to change the way they are going at it along the way. I think transparency, explaining that it is really a very different thing to do, a very difficult thing to do, is the way to go. But I suspect there'll be, again, political implications there.
Yes. Yes. So let's shift again to the recovery. My sense, Olivier, is there's this idea out there that you can just kind of flip the switch on an economy. How do you think about that? Once we're ready for people to go back to work, how quickly would things go back to normal? And the longer we're on lockdown and the longer the economy is significantly below its potential, how will that affect the eventual recovery?
You can flick the switch off very easily. That's what we did. Flicking it on is much, much, much harder. And that's basically what we'll just have to see. I think we're just going to see what happens. You were asking me about the longer run implications.

So I think the issue which is going to start terminating the discussion very soon is the level of debt which is at this stage the programs we've had imply that deficits of about 10% of GDP or more. So the ratio of debt to GDP, given that GDP has gone down and deficits have gone up, debt to GDP ratios, which is what we economists look at, are going to increase by 20%, maybe 25% of GDP.

If we have again bumps, and we have to have a new lockdown, we'll need new programs. And so, debt to GDP could increase even more than that. And you can see how politicians are going to say, "Wow, this is too high." And that's going to create worries. So where do I stand on this?

I think again, we are lucky in a way that we entered the crisis with extremely low interest rates. Now they are basically at zero, which means that the debt service, how much you have to pay on debt when the interest rate is zero, is very small. So you can actually carry a whole lot of debt if you don't have to pay interest on it.

Are interest rates going to remain very low for a long time, which would make things easier? My best guess is yes. All the reasons why they were low before are still there. And you're going to see I think very low interest rates for a very long time.

So I think that we can probably sustain the levels of debt that we're going to have. But it's not an absolute certainty. And in this is what we economists call multiple equilibria, which is that it could be that debt is sustainable if interest rate is zero.

But if investors start being worried, they will not want to lend at zero. They'll want basically to have a risk premium. They'll be ready to lend at a much higher rate. And this by itself will increase the debt service. And this will by itself create the crisis that the investors were worried about.

So we're going to be in a world in which I think investors are going to be a bit hedgy. And there is the risk that somehow, the interest rate goes up a lot and then there is a debt crisis. I think for advanced economies, the central banks will be able to intervene and make sure it doesn't happen. But again, for emerging markets, developing economies, that will be an issue. So this is one more reason to think that there'll be debt defaults in both countries.

MICHAEL MORELL: Yeah. So Olivier, from a long term perspective, do you foresee winners and losers from the perspective of different countries, different kinds of countries, different types of firms, large firms versus small firms? Are there long-term effects that we should expect there?

I think so. The easiest thing to think about are sectors, right? It's very clear that some sectors are going to suffer even in the long run. I think airlines is an example. I think this is anecdotal, but we have all learned how to use Zoom and such things. And found that it was a much more convenient way of doing it than taking planes. It's clear that airlines are going to have a tough time.

It's clear, therefore, that producers of planes are going to have a hard time. It's clear that restaurants, some of the small restaurants, are not going to survive. So it's easy to do that. In terms of countries, I think it's harder. It's clear that the U.S. is not going to come out on top in terms of ability to do things right.

It's going to look bad. I don't know how important it is, but symbolically, I think that the U.S. will not come out of this crisis looking very good. What else? I there is something which had started to happen before the crisis, maybe for the last two or three years, which was what I would call deglobalization.

There was a backlash against trade. And probably justified backlash against trade in the sense that economies had said, "Trade is good." They had not focused on the fact that it's good in general and it can be very bad for some people who'd lose their jobs. So there was already a backlash against trade with the trade wars triggered largely by the current administration.

There was a worry that you were way off about security in supply chains, which is the notion that every fridge that we imported from China could actually listen to what we did. Which was going to lead again I think to less trade, more supply chains.

I think this one is going to reinforce that. And my guess is that we're going to see the contraction of trade. We're going to see shorter supply chains. Probably supply chains closer to home. For example, European firms using Eastern Europe rather than Vietnam.

I think it's going to be a big issue for countries like Vietnam, for example, which have get their growth on exports being part of supply chains. I think that all firms are going to reconsider how they operate in China. And unless they have access to the domestic market, mainly they are there to sell there, mainly they are there to save on costs, I think they are going to think twice.

So we're going to see all these things. Now is this kind of a game changer at an even higher level? I cannot tell. We're all going to be affected by this crisis in various ways. But being specific about what this implies, I cannot go beyond what I've just guessed.

Yeah. So Olivier, you've been fantastic with your time. Let me just ask you one more question and that is if you were still at the IMF, if you were in your old job, what would you be doing every day? What would you be focused on?

I'd be focused on trying to get as much money for emerging and developing economies as I could because again, the amounts that are needed are staggering. And although the IMF can mobilize a lot of funds and others can as well, it's still only a fraction of what's needed. So I would concentrate very much on what can be done to basically increase the funds which are available for those countries.

And where would you find that kind of money?

By naming and shaming. Which countries have their funds at home, that's for sure. But they can basically give what are for them limited amounts of money, and are for African countries a whole lot of money. And we can go into specifics, but there're various ways in which this can be done.

Olivier, thank you so much for joining us.

It's been a pleasure.

This has been a real education for me and I'm sure it will be for my listeners. Thank you so much.

Thank you.

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