A short thread on the economic impact of Covid-19. At a time when human health and our safety is at major risk this is a secondary consideration. However, it’s still important to understand how govts might need to respond 1.
The first thing to understand is that Covid-19 initially at least is what economists call a ‘supply shock’. It negatively affects economic production through disrupting global supply chains and reducing workforce participation/labour supply 2.
We have seen this in China, South Korea and Italy. Key sectors such as automotive and electronic goods are being disrupted through their supply chains. This will get much worse if the epidemic cannot be brought under control 3.
On top of the supply shock we are now seeing a slump in consumer demand and a fall in business investment spending. This is impacting on leisure and business travel & tourism in consumption spend but there OECD and IMF also note that investment decisions are being postponed 4.
(Note that this is different from the great financial crisis. This was a deleveraging shock which impacted on demand first with some longer-term supply effects following via investment and productivity - There are some studies on how financial shocks work... 5.
...see Fornari and Stracca ECB WP n. 1522 in 2013, Benguria and Taylor NBER WP n 25790 in 2019 and others.) The policy response to the GFC aimed at dealing with the deleveraging shock and sustaining demand was coordinated and appropriate, substituting public for private debt) 6.
The OECD have revised projections for economic growth in 2020 and 2021 for Covid 19 are worrying, and could be adjusted down further. If the epidemic does NOT worsen they have reduced their growth projections for 2020 by 0.5% for the world, 0.2% for the U.K., 0.3% for Eurozone 7.
But this is the base case. A broader contagion scenario where the effects of the outbreak do not fade in 2020 could shave 1.5% off global growth. A major shock. It could bring outright recession in 2020-21 in major European economies. 8.
What can policy makers do? With interest rates already near zero expansion in monetary policy will be less effective than during GFC - akin to ‘pushing on a string’ as a Keynesian view might describe it. Generalised Govt spending is not a good response to a supply shock either 9.
Clearly more spending on health emergency is right. Beyond that, rescuing those companies and sectors which are healthy by suspending EU state aid rules as was done in 2008-09, would best safeguard our economies. Anticipating some key long term investment spend could work...10.
...but subject to those supply constraints. Monetary loosening may have some soothing effect on stock markets and financial markets but on its own will not help with some fiscal offset.
Above all we need a coordinated response. 11.
Above all we need a coordinated response. 11.
In 2008 the G20 at least initially - acted together in the GFC. An appropriate coordinated response on this occasion might see further reversion of the trade barriers erected between USA and China. The EU and UK will want to get ‘that’ trade deal done in 2020. 12.
Above all a signal that the G7 and G20 are willing to act together will reassure markets more (and reduce potential secondary demand effects via consumer and business confidence) than individual CB actions on monetary policy, each acting alone (Ends)
*Correction: ‘without some fiscal offset’ in tweet 11.
