Fighting a new kind of recession with new tools: Pandemic Bonds

Prof. Louis Johnston
Prof. Louis Johnston

By Louis D. Johnston

Professor of Economics, College of Saint Benedict | Saint John’s University

History provides plenty of examples for those who make public policy. However, knowing about the past lulls those policymakers into a sense of complacency, of thinking that the plans that worked before can be pulled out, dusted off, and applied to current problems. Sometimes this works if the world hasn’t changed very much.

We live in a radically changed world. The Pandemic Recession is different from every recession the U.S. has experienced since World War II and, perhaps, since the Civil War. We need to think about it differently and enact new policies to fight it. A Typical

Recession versus a pandemic recession

A typical recession involves a shock to the economy, which leads to a fall in spending by households and businesses, which leads to a decrease in employment. There is a feedback effect of the decrease in employment, which leads to further cuts in spending by households and businesses.

For instance, consider the Great Recession of 2007-2009. The financial markets started seizing up in August 2007 and by September 2008 they were in free fall. This made it difficult, if not impossible, for companies to borrow money for expanding their businesses and for households to get the credit they needed to buy houses and cars. This led to declines in both household and business spending on construction, autos, and a wide variety of goods and services. The result was that construction firms, auto companies, and other businesses started laying off and firing workers, who in turn lost income and cut back their spending, leading to a downward spiral of recession.

The Federal Reserve responded by reducing interest rates to zero and engaging in a wide variety of actions to shore up the financial system. The effect was initially to cushion the blow to spending and then to encourage households and businesses to slowly resume their usual levels of spending. As spending gradually increased, businesses started hiring more workers and unemployment started to fall. The Federal Reserve’s actions were the standard policy response in a typical recession.

The current Pandemic Recession is different. This recession began with a shock, but this time it involved shutting down businesses to reduce the spread of COVID-19. This led directly to a decrease in employment, which then led to a fall in spending by households and businesses. The fall in spending is feeding back to further decreases in employment.

Using the typical recession policy response of the Fed reducing interest rates might lead to an increase in spending by households and businesses. However, if the shutdown continues or even if the economy opens up by 50 percent, the potential increase in spending will not materialize or be relatively small and thus the economy could be stuck with high levels of unemployment for a long time.

What is to be done?

The current dilemma for policymakers is that they're trying to fit everything into a typical recession, not a Pandemic Recession. This recession is more like a natural disaster such as an earthquake. When people come out of their shelters after an earthquake, things aren't the same. Bridges have collapsed, buildings have collapsed, highways are impassable. In the same way, we can't simply reboot after COVID-19. We have to clean up from the disaster and rebuild.

Congress and the President enacted a variety of relief measures in March, but since then they have done little while putting the burden on action on the Federal Reserve. This is a mistake. Public policy must break the feedback among unemployment, lost income, and declining spending and reducing interest rates and backstopping financial institutions will not do the trick.

Policy makers, both at the state and federal levels, need to apply fiscal policy. Fiscal policy involves using taxes and spending to affect the economy. In this case, this should take three specific forms. First, we need to provide direct support for households and businesses. This can take the form of tax reductions or eliminations, increased unemployment compensation and food stamps, and a variety of other ways to funnel money directly to firms and families. This would allow them to maintain their usual levels of spending and thus prevent further employment losses.

Second, state and local governments need support from the federal government. Specifically, state and local governments must run balanced budgets and thus when tax revenues fall they must cut spending. The federal government should send funds directly to the state and local government to tide them through this downturn.

Third, the federal government must fight the pandemic by embarking on a crash program to develop testing regimes, tracing programs, and vaccines.

How can we pay for all of this? My view is that the federal government should issue Pandemic Bonds, just as the U.S. did in World War II. Ideally, these would be perpetual bonds with no expiration date. The bondholders would receive perpetual interest payments, but no principal payments. We need to recognize that the we will never pay off the national debt but simply service it and perpetual bonds would go a long way towards doing this.

We can afford to do this. Since 1870, the U.S. economy has averaged two percent growth in terms of inflation-adjusted income per person. That means that the average real income per person will be double today’s level in about 35 years.

We can borrow a bit of that increase today, invest in testing, tracing, and vaccinating, and still be far richer in the future than we are today. We can, and should, borrow from this richer future to pay for the investments we need to ensure that a brighter future comes true.    

Prof. Johnston discusses this more in a Civic Caucus Zoom interview on June 12. Find it at, on their interview page.