The second wave's economic challenge

The second wave's economic challenge
© Bonnie Cash

Earlier this year, U.S. policymakers were caught totally flatfooted by the COVID-19 pandemic, which started in China and spread to Europe before finally reaching our shores. As a result, not only have we experienced our worst economic recession and the highest unemployment levels in the past 90 years. We have also managed to be the country that has experienced more than 20 percent of the world’s COVID-19 mortalities, despite having only around 4 percent of the world’s population.

With clear warning signs now coming out of Europe about the risk of a second wave in the pandemic, there’s no excuse for our policymakers to be caught flatfooted once again. This is particularly the case given the weakened state of our economy and the limited ammunition left in the Federal Reserve’s arsenal. This makes it all the more difficult to understand why the Trump administration still seems to lack a coherent COVID-19 strategy and why Congress and the White House seem unable to agree upon a second fiscal stimulus package.

With winter approaching and having prematurely lifted pandemic restrictions, Europe is now displaying the clearest of signs of being on the cusp of a second wave in the pandemic. In France, Spain and the United Kingdom, cases have spiked to levels above earlier records, forcing a reversal of the earlier easing of restrictions. Meanwhile, Israel, which had considerable success in containing the first wave, has now been forced into a second total lockdown of its economy.


It would be fanciful to think that the United States will be spared a second wave in the pandemic. This is especially the case considering how much more lax the United States has been than Europe on limiting the size of public gatherings, on school and college openings, and on the wearing of face masks. It would also seem to be the case considering how little control the United States has managed to gain over the first wave, with cases still running at a daily rate of around 50,000.

It would be a mistake to underestimate the negative impact that a second wave would have on the U.S. economy. With unemployment still at elevated levels and with the economic recovery already showing signs of stuttering, the last thing that the U.S. economy needs is another supply side shock that is bound to dent both consumer and investment confidence. This is especially the case at a time when the economy is likely to be hit soon by a wave of corporate and household bankruptcies and by renewed weakness in its external markets.

In response to the pandemic’s first wave, the Federal Reserve acted with admirable speed and aggression to support the financial system and stimulate the economy. It did so by reducing interest rates to their zero bound and by increasing the size of its balance sheet by a staggering $3 trillion in the space of barely four months.  

While certainly successful in limiting the economic fallout from the pandemic’s first wave, the Fed’s actions have put it in a very much weakened position to respond to a second wave in the pandemic. This is especially the case considering the damage to the banking system that would result if the Fed were to resort to a negative interest rate policy and to the further reduction in long-term interest rates. A weakened banking system that would be less inclined to lend would be hardly conducive to laying the basis for a sustained economic recovery. 

With the Fed running out of ammunition and with the economy in no position to weather another leg down that could push yet more households and companies over the financial edge, there is no time to lose in providing the economy with more fiscal stimulus. This makes it all the more imperative for Congress and the White House to put country above party and to find some way to compromise on a new economic support package before the November election.  

But judging by the political climate in Washington, I am not holding my breath waiting for that to happen.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.