How do we gauge the impact on global economy from the pandemic? Jean shares his thoughts.
Global economic activity is being deliberately frozen to stem the coronavirus pandemic. This initial shock is very sudden and deep. Yet what matters for asset pricing is the cumulative impact of the growth shortfall over time. We believe that policy actions to cushion the impact of virus shock are nothing short of a revolution. Execution remains a risk, but if successful, the cumulative impact of the virus even under the currently most bearish forecasts would be well below that seen in the wake of the 2008 global financial crisis (GFC) — despite the historic scale of the initial shock.
A banking crisis and overextended household balance sheets led to a “lost decade” of deleveraging after the GFC. This time, the immediate shock is much deeper, but the financial system is not in crisis for the moment. The propagation of the shock is directly linked to the evolution of the virus and the duration of containment measures, in our view. Current economic forecasts, including the most pessimistic, imply long-run economic consequences that are much less severe than the post-GFC impact in both the U.S. and euro area, as the chart shows. The cumulative GDP shortfall in the years that followed was ultimately equivalent to 50% of 2007 GDP in the U.S. For the current shock to be on a similar scale, it would have to morph into a financial crisis, in our view. For now, we see the much swifter and greater fiscal and monetary response this time limiting this risk.
The pandemic has triggered an abrupt, deliberate stop to economic activity. We believe the concept of “recession” doesn’t’ apply here because this is not resulting from the evolution of a usual business cycle. See details in How large is the coronavirus macro shock? The current shock is more akin to a large-scale natural disaster that severely disrupts near-term activity, but eventually results in an economic recovery. The large and immediate loss of income needs to be addressed with a comprehensive policy response, including a new suite of policy measures designed to help bridge cash flow pressures by backstopping household incomes and small businesses – without which the economy could suffer permanent damage. We have seen these measures – both monetary and fiscal – coming together quickly and on unprecedented scale, especially in key developed economies. Policy coordination is critical, as we wrote in Time for policy to go direct.