- Anil Kashyap of the University of Chicago Booth School of Business did not think the US was headed into a recession before the coronavirus pandemic.
- The professor, who used to teach a course called Analytics of Financial Crises, says you have to determine whether the businesses you are trying to help are dealing with liquidity or solvency problems. He says at the beginning of this crisis most businesses were dealing with liquidity problems, which means they were worth saving.
- Kashyap says the US should be looking at all businesses the way a venture-capital firm would view its portfolio. He says we should give money to all businesses struggling with liquidity to buy them some time and then reassess – even though we don’t know which ones will survive, there is a lot of optionality in there.
- Kashyap says you don’t want to look at the stock market as a guide for the economy. “I don’t understand the stock market,” he told Business Insider. “I didn’t sell anything. I didn’t buy anything. I just left it there.”
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Anil Kashyap is a professor of economics and finance at the University of Chicago Booth School of Business. He is also an external member of the Bank of England’s Financial Policy Committee and works as a consultant for the Federal Reserve Bank of Chicago.
Kashyap sat down with Business Insider to discuss his outlook for the US economy and what policy prescriptions would be the most effective. Following is a transcript of the video.
Sara Silverstein: We are live for Business Insider with Anil Kashyap, a professor of economics and finance at the University of Chicago Booth School of Business. And was my professor for one of my favourite classes while I was there, the Analytics of Financial Crises.
I took your class a decade ago at the tail end of the Great Recession, which was caused by a financial crisis. Now we’re in a recession that was caused by a pandemic. How does that difference change the rules for government response?
Anil Kashyap: Well, first, thanks for having me. Great to see you. I guess the biggest thing is because of the public-health crisis, a lot of the usual tool kit that you might deploy kind of goes backward. So normally we want to try to support activity, keep people employed, spending, and all of that. And here it seems like the public-health imperative is to keep people apart, slow down work, and contain the pandemic. And so, having a huge collapse in GDP right now is the right thing probably for the medium term. And so that reverses some of the usual policy prescriptions.
Silverstein: And during the financial crisis, there was a lot of talk about how much money we were spending and debt and deficit. Does that matter right now in our response?
Kashyap: Well, I think in the first go, it was probably just do everything you can to keep the economy afloat and try to give people some confidence. I would say now there’s two things that have come into focus. We may not have spent as wisely as we might have – in particular, underinvesting in testing was a massive failure. And there is this concern that we’ve spent 2 trillion already, if we’re going to do another 2 or 3 trillion, that’s a real bump up in debt. Now the US can afford it, but it is going to change the dynamic over the next 10 years for how you might spend. So when we get around to conversations about things like climate change, these medium-term issues, I think there’s going to be a very different set of conversations because we’ve spent so much on this particular event.
Silverstein: And do you worry about a financial crisis coming at the tail end of what we’re experiencing right now?
Kashyap: It’s too early to tell. I mean, a lot of the policy is set up assuming that we’re in a liquidity problem where we just need to bridge businesses and borrowers and give them time to pay. If you go long enough with no revenue, these business loans are going to go bad. And then you’re going to have to do a bunch of restructuring. The banks are going to take losses. You’re already seeing market stresses.
So I think the jury’s still out as to how big the problems would be for a financial crisis. The good news is most of the financial institutions entered the current period with much higher levels of capital. We’ve done things to shore up the infrastructure of markets, and so we’re better positioned coming in. I mean, this is a huge shock, so it may not be enough.
Silverstein: And do you consider the stock market at all when you’re looking out at what is going to happen with the economy? Are you worried about what the stock market is doing these days?
Kashyap: No, honestly, I don’t understand the stock market. I didn’t sell anything. I didn’t buy anything. I just left it there. It looks like that turned out to be OK. But look, the stock market is very forward-looking. It was panicking well before the lockdown had really kicked in, and now it’s recovering. So, there can be good signals there, but it can reprice quickly too.
And I don’t think you want to watch the stock market as a guide, and, especially for the US economy, so much of the economy isn’t in publicly traded firms. And it’s important to remember a lot of the value is concentrated in a couple dozen firms. So the stock market is not the overall economy.
Silverstein: And what do you think about the Fed’s response so far to this crisis?Kashyap: I think it was great that they were very, very aggressive at the outset. They did a bunch of things that were prudent and supportive. I should disclose that I’ve been assisting in, or I’m on an academic advisory panel to talk about the Main Street program, so those will come online soon. But the idea to cut the interest rate to zero and then try to make sure that the money was flowing was wise and appropriate.
But as Chairman Powell has said, this isn’t fundamentally a monetary problem. The Fed can’t make grants – it makes loans. And I don’t think anybody looking at the circumstances would say, “Oh, let’s just use monetary policy.” I have a friend who says, “Well, the only thing we’ve learned from this crisis is when the Martians invade, the Fed will cut interest rates.” So there are those that say, “This is too far.” But I think the Fed’s done a good job.
Silverstein: And you put out a paper with the three pillars of policy response for the coronavirus pandemic from an economic standpoint. Can you walk us through those and tell us how far, that was like two months ago, so how have we fared on the first two?
Kashyap: Well, I don’t even remember exactly everything we wrote because events have passed us by, but we kind of broke into, do some things right away that make sense now. The thing that was novel at the time we wrote it was to focus on recovery and to realise that we were making decisions in March that were going to be relevant for what had to happen in December. I think that was the part of it that was most novel, and decisions to try to keep firms alive and keep workers attached to firms and things like that are good for the recovery.
Now, that’s all under the forecast that you’ve got a liquidity and not a solvency problem. Keeping somebody stapled to a business that’s going to fail later is not a good thing.
I think since we wrote that, the idea that I’ve come to that maybe hasn’t gotten as much attention is the right way to think about a lot of the problems we’ve been facing for the last month or two is the way a venture-capital firm faces problems, which is right now, there’s a huge amount of risk. There’s a huge amount of uncertainty. You’ve got to try, you have no idea which firms are going to make it and which aren’t. And so one response to that is to say: “Well, let’s just be very conservative. Let’s keep the firms that look most safe. Be sure to give them money, that way we’re not going to waste any. And that’s the way to defend the economy and protect the public purse.”
I think the way a VC firm or VC investor would see it as, “There’s a huge amount of optionality. So let’s play for time. Let’s give a lot of money in the next few months to try to keep everybody essentially as they were in February. When you get to the summer, then maybe you reassess and you say, ‘OK, some of these businesses, maybe they are going to die and we can’t save them.’ So let’s start withdrawing support there. Let’s buy a bit more time to get to the fall and keep going it like that.” So I think recognising that there’s a lot of option value to preserving choices and not giving huge grants now to tide people through for the long run when you’re not sure is probably less good than trying to give people a way to play for time.
Silverstein: And do you still think it’s possible that the recovery could be rapid once the health issue is over?
Kashyap: It could be. I think that’s looking much less likely now than it was three months ago. Partly, I go back to the testing thing. The fact that we don’t have the testing takes choices off of the table that we would have. If we had better certainty over who definitely wasn’t sick, we could send them back to work. We could let them go to restaurants and reopen parts of the economy. We could isolate the people that are sick and make sure that they’re protected. We could treat them sooner so they don’t die as much. Kind of every single problem we have is enhanced, if you can tell who’s sick and who isn’t. And the fact that we’re so far behind on that means that some of the hope for a rapid recovery, I think, has been taken away. So I’m less confident of that.
Silverstein: And I remember you talking about the liquidity issue versus the solvency issue during the financial crisis, and now putting the coronavirus pandemic through that same lens. What sorts of businesses do you think are most at risk for being a solvency problem?
Kashyap: Well, anything that requires close social contact, the longer this goes, not because they have fundamentally bad business models, but I think there’s a combination of things. First, a lot of people figured out how to use e-commerce and order in ways that they never did before. So some of these retailers are just going to discover that people have moved on and don’t want to take the risk. If things became normal very quickly, people might go back to what they’d been doing in the past and be willing to continue to shop the way that they have. But that doesn’t mean that they’re necessarily going to do it in the short run.
So, you take one of these businesses that didn’t have high margins, starve them for revenue for six, nine months and there may just not be much value left. And so, anybody that’s in a low-margin and high-social-contact model is going to be under stress.
Silverstein: And we have a few questions from the audience. How long do you see the economy being affected? And when do you estimate it will start to rebound? I understand that it’s not a fair question.
Kashyap: Yeah, well, so they should trust it to the extent they paid it. They didn’t pay anything so shouldn’t bet any money on this. But I think the odds that we’ve hit the trough by September are pretty high, and it will be growing at that point. But that’s very different than saying it’s going to feel like normal. I was just looking at the blue-chip consensus forecast. Those numbers have by the end of the year that we’d be kind of 5% below where we were at the beginning of the year, which will be an awful, awful year, worse than the financial crisis. So I kind of try to stay away from this alphabet soup, W, V, U, L, all that kind of stuff. I think it’s more helpful to think about how far below where we were at the end of 2019 will we be at the end of 2020 and the end of 2021.
Because whether you get there by zigging and zagging probably isn’t going to matter that much. And even if we got back to where we were at the end of 2019, whether we’ll have as many people employed, I think is pretty doubtful. So it’s still probably not going to feel great. And then we will have given up all the growth. So this is going to be a really disastrous couple of years for the economy. And I don’t think just because we’re growing fast it’s going to feel good if you’ve got unemployment rates above 10% or above 8% when we were 3 1/2 just a couple months ago.
Silverstein: And you are one of the founders of the IGM Forum at Chicago Booth, where you survey economists about whatever’s going on right now. Where are economists in agreement, and where is there a lot of disagreement around the coronavirus?
Kashyap: I think, well, at least the members of our panels, it’s only 40 people, but they’re carefully chosen and the wisdom of crowds kicks in pretty quickly. I think we had a lot of agreement that attending to the public-health problems was not a tradeoff versus economics, because the sense was that if you don’t get the public-health problem under control, you’re going to run into trouble later on. There wasn’t much of a tension there, even though it was painted that way by some people. There’s quite a bit of support for that.
I think the question of whether you should be aiding businesses or aiding people directly is one where there was some difference of opinion. And again, I think that comes down to not being sure how long this is going to go on. I think everybody agrees with the idea of keeping people attached to their firms so that they can get back to work quickly is a really good thing, but that’s not going to work if we’re nine months before we’ve got people coming back. And so whether you think that was the right thing to do or whether we calibrated the response to that the right way, I think is a pretty different question. I think economists are crazy about testing. You can’t find an economist that won’t say, “We should be testing, testing, testing, testing continuously, and then testing some more.”
Silverstein: And the second pillar of your thing was about facilitating, not just production and decision-making, but also support. Was that about speed in which we’re able to get some of these services and policies enacted so that they could actually preserve people in their jobs?
Kashyap: Yeah. And so you want to definitely give people the capacity to hang on. And I think it was very important to try to get money into people’s hands early on. We did that to some extent. We did it in an awkward way because it turns out that our ability to write checks and get them distributed is still kind of clunky. It’s amazing 10 years after the financial crisis that you still can’t get unemployment insurance calibrated at the state level to be kind of appropriate for the state. So that $US600 per person was kind of a clunky way to do it. Probably wasn’t the ideal response, but getting the money out fast was good. I think giving grants to small businesses for a while, it was a good idea. How long you can keep doing that is a different question, and whether you want to keep doing it?
And it comes back down to the thing we were talking about liquidity versus solvency. The way I think of the business sectors, you’ve got a bunch of firms that are going to be OK, no matter what. You’ve got a bunch that were barely alive in February before this started. And then you have the set in the middle and you really wanted to preserve that set in the middle. Now as time passes, that set is shrinking. Some of those are falling into the dead, no matter what you do. And some of them have emerged and are making money now because maybe they’re doing something that’s kind of countercyclical. But I think it’s still probably the case that the vast majority of businesses are in that middle bit, where it’s too early to tell whether you can keep them alive. So think of it like a VC problem where you keep giving them some money and then maybe tightening up the terms as you get more information.
Silverstein: And do you think we were already headed for a recession before coronavirus?
Kashyap: No. I think the economy was pretty strong. If you just look at all the contemporaneous data, it was looking pretty good. Economists that have studied this say that recessions don’t die of old age. There was no reason that we had this fall into recession. So I wasn’t forecasting a recession in the next six months when this came up.
Silverstein: And another question from the audience. They’re wondering, in the long run, do you think there are going to be potential behaviour changes that could affect demand? And you touched on this a bit, but–
Kashyap: Yeah, I mean, I think there’ll be a lot of medium-term readjustment in terms of what happens. I mean, one thing is lots of businesses somehow fold and governments are going to come out of this with more debt. And so whether you’re going to see savings patterns change, whether you’re going to see people just more cautious having seen what happened. We know from the Great Depression, because it was long enough ago and there was lots and lots of studies, that people born and lived through the depression behaved differently than people that never saw it. If this goes on for multiple years, whether all the people that were coming of age financially and just becoming independent, are going to be haunted by this, I don’t know. Certainly depends how quickly we get a vaccine, if we get a vaccine, and so on. So it’s too early to tell, but I think there could be some big changes.
Silverstein: And I promise I’ll let you go in a few minutes. Is there anything that you see? I know there were a lot of misaligned incentives during the Great Recession. What misaligned incentives do we have to deal with right now?
Kashyap: You mean cases where we’re going to be rewarding bad behaviour, or?
Silverstein: Absolutely, yeah. Whether it’s adding too much to unemployment insurance or, whatever.
Kashyap: Well, so yeah, so the $US600 payment means that there are plenty of people right now that are probably getting more from unemployment than they would have gotten if they were working. I don’t think for three months, given the size of the shock, that’s such a disastrous thing. If that gets extended for six months and then nine months, and people start to realise, “Hey, this is a pretty good deal.” And you can’t actually get those people to come back to work, that will be a problem.
I worry about state and local governments that are getting assistance that had been kind of living beyond their means. I’m talking to you from Illinois. Anybody who thinks that the coronavirus is the reason why the city of Chicago and the state of Illinois has fiscal problems is just illiterate. They haven’t been paying attention. We’ve had these chronic problems, that’s been exacerbated.
Now, it’s true. We didn’t choose to have a pandemic to try to get out of this, but there’s going to have to be, I think, a lot of businesses that were highly levered coming into this that are going to take on more debt. You’d like to see some loss-sharing there with the people that provided credit before you started giving them just out and out assistance. So one thing that I think is important is to get people that are given, let’s say, more loans to write down the debt that’s going to go bad and make sure that the existing creditors bear some of those costs and we don’t just take government money to bail out the prior people and leave the government holding the losses. That’s something to keep your eye on.
Silverstein: And finally, is there anything that any government is doing, US or anywhere in the globe, that you feel like where they’re massively misunderstanding part of this scenario?
Kashyap: No, no. I think if you follow closely Sweden, the rhetoric fluctuates from week to week as to whether Sweden’s made a grave error or is actually got the best long-run strategy. So I think it’s too early to tell. I mean, I assume you and your audience knows a little bit about Sweden has not tried to go to maximum lockdown. They have tried to say, “Do social distancing, but be smart about it.” They haven’t closed restaurants and all the rest of it. They closed their borders so Swedes are there by themselves and they’re a pretty homogeneous society. You wouldn’t want to take Sweden as a model for what you could do in New York City or Chicago or something, but this question of whether you could even follow that policy in a place as diverse as many other countries is something that’s interesting.
And in terms of who’s really blowing it, I don’t think we know. In terms of whether we’ll be able to look back and say some of these countries organised their testing and quarantining and did that in a much more efficient way, I think that’s something where we’ll probably get enough evidence to make a judgment. Maybe not yet, but by next year.
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