Dear Mr. Kudlow:

I was thinking some more about what I wrote earlier to President Trump (summary below) and would like to share my thoughts with you. Maybe if you find it useful we can eventually write a joint paper.

From a political point of view, a pandemic puts politicians and government servants under extreme pressure to demonstrate that they are in control of the situation. This often results in extreme measures that take away power and control from individual citizens over their own lives. While I sympathize with the predicament of government officials, I think many such extreme measures are misguided, and so often cause individuals to actively fight and undermine the efforts of their government. The primary problem of most such demonstrations of control is that they do not consider the full and varied scope of the predicament faced by the individual citizen, and in particular the micro-economic plight of the individual.

From an economic point of view, it seems to me that a pandemic has two main effects - first a demand crash, and then a labor supply crash. When using interest rates as the tool, fighting a demand crash is often done by lowering interest rates; while a labor supply crash and the resulting wage inflation is usually fought by raising interest rates. The conflicting strategies required by a pandemic therefore causes extreme schizophrenia in central bankers or politicians attempting to mitigate its effects using interest rates.

If we dig a little deeper into the motivation/thinking of the average citizen I think we have arguments for better strategies than lowering interest rates, and may even in the balance have an argument for raising them instead. Plus, we may come up with better strategies to handle the pandemic by obtaining the unstinting cooperation of citizens.

The individual fear everyone recognizes is the fear of catching and dying of the disease. For those who live with loved ones, there is also a fear of transmitting the disease to their loved ones, and causing their suffering or death. This primary fear causes people to avoid normal daily activity and interaction, and to stay at home, directly causing a demand crash. This fear also results in support for government efforts like quarantines, which also produce a demand crash. The demand crash causes businesses, especially small businesses, to avoid bankruptcy by laying off employees, resulting in a labor glut. People understand this side effect will occur, and will attempt to compensate by becoming more frugal, enhancing the demand crash.

For many of us with adequate resources, staying at home or even undergoing a 14 day mandatory quarantine may be an annoyance, but it is not an existential problem. But for a vast number of Americans, not working will result in effective bankruptcy with a possible loss of residence (whether owned or rented) as a consequence. Even if homelessness is not an immediate consequence, their future existence can be severely compromised. This second fear causes people to venture out anyway. This is good in that it mitigates the demand crash, but in severe cases will cause them to break quarantine. If actually confronted with a personal existential situation, they will actively subvert and oppose government imposed quarantines, and may even resort to looting.

There is a third fear we need to recognize. Everybody in a pandemic situation knows that there is a possibility they may be subject to a quarantine or shortages, and that distribution and promissory enforcement systems may break down. As a result, people will become more frugal to conserve resources. The more enterprising and active ones with adequate capital will take steps to secure physical resources before they become unavailable. Those without adequate capital to secure physical resources will attempt to convert their money to cash so it is available both immediately, as well as not be subject to lock ups because other financial systems become unreachable.

Finally, when quarantines are actually imposed, the affected individuals will become unavailable to the economy. This results in both a demand crash, AND a labor supply crash. This is why the third fear is well founded - a large enough labor supply crash WILL result in a distribution/supply system breakdown.

Because the demand crash is a direct result of the primary fear, lowering interest rates will NOT prevent the demand crash. Lowering interest rates affects only one component in this overall picture. Businesses affected by the demand crash will be able to postpone bankruptcy, but only for a short time. Knowing their future, businesses will prefer to close rather than take on additional debt. Additionally, low interest rates mean individuals will have no reason to keep money available in the financial system, so many will extract it as cash and prefer to keep it under a mattress in a crisis. We should let them do so if it boosts their confidence, especially since financial distribution systems may become unreachable, but high interest rates on deposits will tempt them into putting the money back in the market.

So what else can we do to build confidence?

I think the first thing we can do is to eliminate the fear that encourages people to break quarantine. President Trump seems to have taken the first baby step by talking about paying for the test. We should also be thinking about financially supporting people who become confined during a quarantine. There is a huge societal benefit when people willingly cooperate with a quarantine, and the best way to get them to do that is prevent the financial disintegration of the individual subject to quarantine. We dont want to eliminate the second fear completely, as we dont want to lose the demand they generate when they are out and about and earning. If we support them just during a quarantine confinement, they can continue to exhibit much of their normal demand by using now widely available delivery services instead of physically travelling to pickup items. Similarly, because we do not know precisely what demand their confinement eliminates, we should not put any rules in place as to what they can do with their quarantine support money. As a confidence building measure and to ensure that the "no rules" rule is respected, they should explicitly be able to withdraw the support money as physical cash if they so choose. They should not have to provide any accounting of how it was spent.

One objection will be that people may game the system to get support money even when they dont need it. We can prevent this by making them agree to work for a time equal to the time they were under quarantine at any crisis task the government specifies after the quarantine, and explicitly state that it may include doing sanitation work! Another is to put a limit on the amount paid out, say $200/day of missed work. With this kind of number, even if we paid 1% of the US population for 14 days of quarantine each (10 work days), we would spend only 6.8 billion dollars - i.e. about the amount Congress authorized in excess of what the President originally asked for. Plus we get a labor pool of "vaccinated" or known healthy individuals to draw on for crisis management work.

Second, we should make it clear that during the crisis we will favor expenditure on labor and training over expenditure on capital goods, physical assets, and stock. This will discourage the hoarding of assets, making them available during the crisis, and increase the money available for labor. It should get President Trump a larger voting pool if it actually happens. Such a public position may temporarily tank the stock market, but I think one needs to remember that the stock market is just one measure of the health of the economy; and for voters the micro-economy around them is more important than the macro-economy.

I hope that this attempt to kick thinking out of the box was useful, and wish you all success in managing the economy.

Sincerely,