A K-shaped recovery and the role of fiscal policy

The spine of the letter represents the fall in activity at the start of the pandemic. Then there is a split, which leads to the two ‘arms’ that capture the different directions taken by economic activity in different sectors.

By: Date: March 2, 2021 Topic: Macroeconomic policy

This opinion piece was originally published in the Money Review Section of Kathimerini and in El Economista.

The shape of the post-pandemic economic recovery has gone through many letter characterisations, from V to W, to land more or less on the letter K. The spine of the letter represents the fall in activity at the start of the pandemic. Then there is a split, which leads to the two ‘arms’ that capture the different directions taken by economic activity in different sectors.

Digital technology and pharmaceuticals, for example, have seen their activities boom. On the other hand, sectors including hospitality, tourism, and also energy, have seen partial or complete standstills. There have therefore been clear winners and losers from the pandemic.

Evidence shows that this K split that characterises different sectors holds also for individuals at opposite ends of the income distribution. After initial reductions in everyone’s income, the wealthy are now recovering fast, while lower earners are still struggling.

Any attempt to design further fiscal support for the remainder of the pandemic must account for this split, or it risks missing the point. The main role of fiscal policy therefore will be to support only those segments of the economy and society that are on the declining ‘arm’ of the letter K.

This is very much the logic behind the most recent fiscal rescue package in the US, which has three purposes. First is dealing with the health aspects of the pandemic, including assisting vaccination and making schools safe. Second is supporting those who have lost their jobs. Third is providing cash transfers to those with lower incomes. .

How does this K-shaped recovery apply to the fiscal needs in the EU? In a letter to her G20 colleagues, on 25 February, US Treasury Secretary Janet Yellen urged her counterparts, at the very least, not to step back from fiscal support, saying among other things that “If there was ever a time to go big, this is the moment”.

This will resonate with EU leaders who are about to discuss whether, when and how to return to the EU’s common fiscal rules, which are temporarily suspended. The European Commission’s latest economic forecast projects growth of 3.7% for the EU economy in 2021, but that estimate is very uncertain and growth will vary significantly among EU countries. There is therefore, an additional K-type split implied, beyond sectorial performance or income, that has to do with the geographical pattern of recovery.

Given differences between EU countries in the speed of recovery, when it comes to fiscal policy in the EU, the most urgent question is when the common fiscal framework should be reinstated. A recent study showed the differentiated impact of the pandemic based on how dependent each EU country’s economy is on external trade and on proximity-based professions, like services. This dependence will define also the pace of recovery.

The first evidence of variability in the recovery can be seen in the pace of new business start-ups compared to the rate of bankruptcies. Both numbers collapsed at the start of the pandemic. However, by the third quarter of 2020, the registration of new businesses had returned to pre-pandemic level, on average for the whole EU. Bankruptcies remain a lot lower than in 2019. This suggests that support continues to be extended to too many firms that would otherwise go bankrupt. Should fiscal support be phased out and such firms be allowed to fail instead?

A closer look at national data shows huge differences between countries. For example, the rate of new firm registrations was higher in France and Belgium (by 21.5% and 14.3% respectively), in Q3 2020 than in the same quarter in 2019. It was lower in Germany and the Netherlands (by -14.6% and -13.3%). The rate of bankruptcies was very low everywhere: France, -34.9%; Belgium, -32.3%; and -27.2% in Germany. The extent of fiscal support needed is therefore very different in different countries and it makes little sense to revert to the common fiscal rules framework while such huge differences exist.

Last, the unemployment rate in the EU has gone up by only 1.5% during the pandemic. This is a huge success if one considers the depth of the recession and is due to concerted fiscal efforts to keep people in jobs. However, a closer look at the numbers tells us that there has been a widening of inequality when it comes to preserving employment. This is very visible across the lower educated, the young and women. The evidence shows that the pandemic risks wiping out the progress in gender equality of the last 25 years. Job-retention schemes and national fiscal policy overall will have to be a lot more targeted to address these split effects.

For the time being, fiscal policy design should not be based on averages as they mask these K-type splits. In the EU, for as long as differences in the pace of recovery are economically significant, fiscal policy at the national level needs to be allowed to deviate from EU rules.

Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read about event More on this topic

Upcoming Event


How can we support and restructure firms hit by the COVID-19 crisis?

What are the vulnerabilities and risks in the enterprise sector and how prepared are countries to handle a large-scale restructuring of businesses?

Speakers: Ceyla Pazarbasioglu and Guntram B. Wolff Topic: Macroeconomic policy
Read article More on this topic More by this author



The cost of China's dynamic zero-COVID policy

What does zero-COVID mean for both China and the global economy?

By: The Sound of Economics Topic: Global economy and trade Date: May 11, 2022
Read article Download PDF

Policy Contribution

European governance

Fiscal support and monetary vigilance: economic policy implications of the Russia-Ukraine war for the European Union

Policymakers must think coherently about the joint implications of their actions, from sanctions on Russia to subsidies and transfers to their own citizens, and avoid taking measures that contradict each other. This is what we try to do in this Policy Contribution, focusing on the macroeconomic aspects of relevance for Europe.

By: Olivier Blanchard and Jean Pisani-Ferry Topic: European governance, Macroeconomic policy Date: April 29, 2022
Read about event More on this topic

Past Event

Past Event

From viruses to wars: recent disruptions to global trade and value chains

How have events in recent years impacted global trade and value chains and how can we strengthen these against future disruptions?

Speakers: Dalia Marin, Adil Mohommad and André Sapir Topic: Global economy and trade Date: April 27, 2022
Read article More on this topic More by this author


China’s Covid policy to be year’s largest economic shock

Beijing’s ‘dynamic zero-Covid’ policy could devastate the domestic economy, but the effects will also be felt globally.

By: Alicia García-Herrero Topic: Global economy and trade Date: April 26, 2022
Read article


European governance

How to reconcile increased green public investment needs with fiscal consolidation

The EU’s ambitious emissions reduction targets will require a major increase in green investments. This column considers options for increasing public green investment when major consolidations are needed after the fiscal support provided during the pandemic. The authors make the case for a green golden rule allowing green investment to be funded by deficits that would not count in the fiscal rules. Concerns about ‘greenwashing’ could be addressed through a narrow definition of green investments and strong institutional scrutiny, while countries with debt sustainability concerns could initially rely only on NGEU for their green investment.

By: Zsolt Darvas and Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: March 8, 2022
Read article Download PDF More on this topic


European governance

Greening Europe’s post-COVID-19 recovery

This Blueprint includes some of the Group’s most prominent voices on the different aspects of the multidimensional issue of green recovery.

By: Simone Tagliapietra, Guntram B. Wolff, Georg Zachmann, Laurence Tubiana, Laurence Boone, Antoine Dechezleprêtre, Jean Pisani-Ferry, Klaas Lenaerts, Thomas Wieser, Ottmar Edenhofer, Mirjam Kosch, Michael Pahle, Ian Parry, Robert N. Stavins, Sabine Mauderer and Tomasz Koźluk Topic: European governance Date: February 23, 2022
Read article Download PDF More on this topic

Policy Contribution

European governance

The failure of global public health governance: a forensic analysis

The emergence of the Omicron variant in November 2021 was a stark reminder of the high overall cost of the persistence globally of extremely unequal access to vaccines and treatments. What are the reasons for these failures of global collective action?

By: Anne Bucher, George Papaconstantinou and Jean Pisani-Ferry Topic: European governance Date: February 17, 2022
Read about event More on this topic

Past Event

Past Event

A debate on fiscal rules and the new monetary strategy

Presentation of the Yearbook of the Euro 2022.

Speakers: Maria Demertzis, Fernando Fernández, Gonzalo García Andrés, José Carlos García de Quevedo, Pablo Hernández de Cos and Jorge Yzaguirre Topic: European governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: February 17, 2022
Read article More on this topic

Blog Post

Venture capital: a new breath of life for European entrepreneurship?

Whether the dynamism of European venture capital of the past two years can be sustained and kick start a credible alternative to bank finance in the European Union remains to be seen.

By: Maria Demertzis and Lionel Guetta-Jeanrenaud Topic: Banking and capital markets Date: February 10, 2022
Read article Download PDF More on this topic More by this author

Policy Contribution

European governance

Does Europe need a Health Union?

This Policy Contribution assesses the rationale for a Health Union. Section 1 provides a historical perspective on health provisions in the European Union treaties. Section 2 gives an overview of the achievements of EU health policies. Section 3 explores the need for an overall health strategy and section 4 identifies the areas that would benefit from closer integration.

By: Anne Bucher Topic: European governance Date: February 8, 2022
Read article Download PDF More on this topic

Working Paper

The effect of COVID certificates on vaccine uptake, public health, and the economy

An analysis of the incentive effects of COVID certificates on vaccine uptake, health outcomes and the economy.

By: Miquel Oliu-Barton, Bary Pradelski, Nicolas Woloszko, Lionel Guetta-Jeanrenaud, Philippe Aghion, Patrick Artus, Arnaud Fontanet, Philippe Martin and Guntram B. Wolff Topic: Digital economy and innovation Date: January 17, 2022
Load more posts