An interest rate cut might be a bonus for homeowners with mortgages and give share investors a temporary sugar hit, but it's not going to do much to save the economy from coronavirus.

That's because there is both a "demand shock" and a "supply shock" from the disease. Let me explain.

First, the demand shock. This is where people aren't buying as many goods or services as they normally would, in this case, because of coronavirus.

There are two main reasons for this.

One is that most people are worried about how bad this is going to get and many people are concerned about losing their job or having reduced shifts, as well as seeing the value of their investments plunge, so they cut back spending to increase their savings for a rainy day.

The second is that people are becoming hesitant about going to certain public places, with Chinese restaurants, for example, already feeling the pinch.

One idea behind a rate cut is to put more cash in the hands of borrowers so they go out and spend it.

But if they're not going out anyway, then it's unlikely lower rates will result in higher retail or services spending.

Even before coronavirus, with rates at record lows and household debt near record highs, it was already doubtful how much another cut could do to boost demand.

Rate cuts can't stop coronavirus disruptions

If a rate cut won't do much to help with the demand shock, it'll do virtually nothing to ameliorate the supply shock.

A supply shock is where businesses simply can't get hold of the inputs they need to make things or the goods they are trying to sell to consumers.

There are already widespread anecdotes of retailers running short of made-in-China goods and lengthy delays for most things made-to-order that come out of Australia's biggest trading partner.

Reports from reputable analysts, such as Citi's economics team, show that Chinese production is coming back online, but is still about half of what it was before the country's extreme quarantine measures and lockdowns came into effect during an extended Lunar New Year holiday.

That's not to mention the prospect of shutdowns spreading to other major suppliers and, ultimately, to shutting down various operations in Australia as their workers and/or customers get sick or quarantined.

So, even if rate cuts do significantly boost demand (which is unlikely) they won't help keep businesses open when they run out of things to sell, parts to assemble or workers to do the jobs.

In a worst-case scenario, many businesses are going to be effectively shut until the coronavirus outbreak in their region peaks and subsides, or until a vaccine or effective treatment is developed and released.

This could leave many firms without income for months.

Businesses without income don't need workers, so it will result in potentially hundreds of thousands, if not millions, of Australians out of work for some period.

Some will use paid leave, as is the case with thousands of Qantas employees who are being urged to take a break as the airline cuts capacity because of the virus, but others don't have that luxury, such as casuals or new staff with low leave balances.

For those without paid leave, no work means no pay. But the bills keep coming in, just as they will for businesses with no income.

Many Australians vulnerable to debt default

Particularly for those individuals and companies with large debts, any financial buffer they have may be quickly exhausted, leaving them vulnerable to default and bankruptcy.

In the case of individuals, a regular ME Bank survey conducted most recently at the end of last year showed that nearly one-in-five households didn't think they could raise $3,000 within a week to cover an unexpected emergency.

Ten per cent said they would have to take drastic action, like selling an important possession, to do so, while a third said they would have to cut other spending or take out a new loan to pay a sudden, large bill.

If they can't find $3,000 for an unexpected bill, imagine how these people living on the edge would cope with the sudden loss of one or both household incomes?

Amongst mortgage borrowers, the Reserve Bank says about 30 per cent have less than one month's prepayment buffer. While half of those appear to be by choice (such as investor or fixed loans) that leaves around 15 per cent of people with mortgages who are very vulnerable to even short-term income disruptions.

This is where the economic risk of coronavirus increases from downturn, or perhaps a short and relatively mild recession, to the possibility of a severe recession or even depression.

If tens of thousands of fundamentally sound firms hit by the complete or near-total loss of their income for several months go out of business, then hundreds of thousands of jobs will be lost.

Those unemployed workers, not to mention many small business owners, in turn will be unable to pay their bills and debts, leading to mass defaults.

This then would feed back into the banks, which would suffer rapidly increasing bad debts.

Forced property sales would push down house prices, crystallising many of those loan losses, leaving the banks in severe financial difficulty.

It sounds terrible because it would be.

ANU economics professor (and former Reserve Bank board member) Warwick McKibbin and PhD student Roshen Fernando warn that a worst-case coronavirus pandemic could wipe 7.9 percentage points from economic growth this year, and even a milder worldwide outbreak could lower growth by 2 percentage points.

Bear in mind that Australia's annual GDP growth to the September quarter last year was just 1.7 per cent and is expected to remain stuck below 2 per cent in the December quarter figures being released by the ABS today.

So, unless coronavirus is essentially contained within China, which already looks extremely unlikely, the best-case scenario in this modelling is basically for Australia's economy to shrink this year.

'Targeted' stimulus

But there are ways to avoid this worst-case outcome, even if coronavirus proves to be every bit as bad as some fear.

The Government has flagged a "targeted", "measured" and "scalable" plan to stimulate the economy.

The Prime Minister has offered no further details on what this plan, being developed by Treasury in consultation with the Reserve Bank, will be.

So here's a few suggestions.

Coronavirus is likely to be a short-term hit — even if it lasts until the end of the year, once it runs through the population or a vaccine is developed, it will come under control.

So, launching long-term infrastructure projects that won't even be able to get underway before the crisis ends is not the kind of stimulus needed.

That may be what the Prime Minister meant by "targeted" and "measured".

But what is desperately needed are ways to keep businesses alive and households afloat until the worst of the illness, event cancellations, lockdowns and quarantines pass.

A rate cut doesn't do this — it doesn't matter how low your monthly repayments are, if you have no income and no existing buffer, you will soon default.

Debt holiday

What may be needed instead, in a worst-case scenario of mass disruption (like we've seen in China), is Reserve Bank and/or Federal Government intervention to support the banking system in giving a debt repayment holiday to borrowers affected by coronavirus.

If creditors can be persuaded or forced not to call in debt repayments for a limited period during the crisis, and the authorities can underwrite the lenders so they themselves don't go bust while doing this, then this could be the kind of life support that allows the economy to rapidly return to normal once the emergency passes.

It's what China is already doing, with the advantage (at least in these circumstances) of being a command economy where the Government owns the banks and can simply tell them what to do.

The alternative, of letting all businesses and households without any savings buffer go broke, will simply transform a health crisis into a debt and financial crisis, making it more painful and much longer-lasting.

Those without debts may also need financial support. Italy has announced tax credits for businesses hit by revenue drops, and there's talk in Australia of increased business investment write-offs or bringing forward personal tax cuts.

None of those are likely to be very effective.

If you're in a sector where income has dropped to zero, or close to it, a tax credit will be too little, too late for many.

If you're an individual out of work then you're probably not paying tax anyway, so a tax cut is useless.

For individuals, a more effective approach may be helicopter money — that's basically where the Reserve Bank deposits cash in everyone's bank accounts.

If that sounds far-fetched, it's already happening in Hong Kong, where the Government is giving every permanent resident over 18 years of age $HK10,000, or nearly $2,000 Aussie.

In Australia, such payments could perhaps be limited to people out of work due to coronavirus — a long-overdue Newstart top-up if you like.

It may not be enough to buy breathing space for many Australians struggling under record household debts, but it would help cover other living expenses.

If the Government both forced and supported the banks not to foreclose on loans and provided extra cash to tide the unemployed through until the virus crisis was over, it would probably be a good investment in both a rapid economic rebound and improved human welfare.

The coronavirus epidemic is not near this stage yet, but the World Health Organisation has said we are already in "uncharted territory" with this disease so now is probably also the time to start planning for some very unconventional economic policy responses.