When (and how) to end the Covid-19 lockdown has become the leading political question in every afflicted country.
German Chancellor Angela Merkel has gone so far as to describe the increasingly intense debate as a collection of “discussion orgies.”
At the heart of the issue is the question of how to distribute the soaring economic and fiscal costs associated with the crisis. The closest historical analogy is to the 20th century’s interwar period, which offered a crash course in navigating extreme fiscal circumstances.
Like the Covid-19 crisis, World War I was a prolonged affair, lasting much longer than people initially expected.
In the summer of 1914, many assumed that it would all be over by Christmas. Likewise, in early 2020, many hoped that a brief shutdown would stop the spread of the virus in its tracks. In both cases, the economic shock was grossly underestimated at the outset.
No belligerent could pay for the massive military mobilisation through taxation alone, so the war was funded through borrowing, and much of that was eventually monetised by central banks.
Such action was necessary and appropriate for dealing with the emergency, and central bankers duly congratulated themselves for their can-do attitude and patriotism in the face of extenuating circumstances.
The impact on budgets was relatively uniform across countries. By the last year of the war, military expenditures as a share of deficits were around 70% in Italy, the United States, and the United Kingdom, 80% in France, and over 90% in Germany.
Price increases in each country were also broadly comparable: they more than doubled, but there was no radical inflation outside of Russia.
The bigger differences emerged after the war. The UK and the US, facing massive debt-servicing costs from their wartime liabilities, tried to return to normal as quickly as possible.
That meant pursuing a balanced budget through substantial tax increases, including unprecedentedly high tax rates for the rich. This approach – the modern world’s first experience of induced austerity – choked off demand and triggered an exceptionally deep but short-lived recession.
By contrast, a defeated Germany, like almost every other central European country, feared severe deflation. With the population exhausted and demoralised by the conflict and its outcome, the government was not inclined to impose new taxes.
Policymakers considered social programs necessary for maintaining domestic peace and order, so they relied on the central bank to do the financing, and continued to spend freely on welfare payments and public-sector employment.