Travel bans. Sporting events cancelled. Mass gatherings prohibited. Stock markets in freefall. Deserted shopping malls. Get ready for the Covid-19 global recession.
Up until a month ago this seemed far-fetched. It was assumed that the coronavirus outbreak would be a localised problem for China and that any spillover effects to the rest of the world could be comfortably managed by a bit of policy easing by central banks.
When it became clear that Covid-19 was not confined to China and that the economic effects would be more widespread, forecasts started to be revised down. But central banks, finance ministries and independent economists took comfort from the fact that there would be a sharp but short hit to activity followed by a rapid return to business as usual.
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This line of thinking has exact parallels with the events of 2007, when it was initially assumed that the subprime mortgage crisis was a minor and manageable problem affecting only the US – and nobody needs reminding how that ended.
If history is any guide, the global economy will eventually recover from the Covid-19 pandemic, but the idea that this is going to be a V-shaped recession in the first half of 2020 followed by a recovery in the second half of the year looks absurd after the tumultuous events of the past week.
What’s more, policymakers know as much. The Federal Reserve – the US central bank – did not need to be told by Donald Trump that it needed to cut interest rates and resume large-scale asset purchases known as quantitative easing. The world’s most powerful central bank pulled out the stops on Sunday night by slashing rates to nearly zero and pledging to expand its balance sheet by $700bn.
In the coming weeks the Bank of England can be expected to cut interest rates to 0.1%
In the UK the coordinated response by the Bank of England and the Treasury last week was seen as a textbook example of how policymakers ought to respond to the crisis. It was, though, only the start. Airline companies will quickly go bust unless they receive financial assistance. The same goes for retailers, many of them hanging on by their fingertips even before Covid-19. Britain has a new chancellor of the exchequer in Rishi Sunak and, from Monday, a new governor of the Bank of England in Andrew Bailey, and they will both be aware that the risks of doing too little too late are far greater than those of doing too much too soon.
So, in the coming weeks the Bank can be expected to cut interest rates to 0.1% – the lowest they have ever been – and to resume its QE programme. Sunak will have to add to the £12bn he has set aside to deal with Covid-19.
As in 2008-09, the authorities in the eurozone have been slowest to act but there have been welcome signs in recent days – from Germany, most significantly – of the need for governments to spend, and spend big.
It has been clear from the start that Covid-19 affects both sides of the economy: supply and demand. The supply of goods and services is impaired because factories and offices are shut and output falls as a result. But demand also falls because consumers stay at home and stop spending, and businesses mothball investment.
Conventional policy measures – such as cutting the cost of borrowing or reducing taxes – tend to work better when there is a demand shock. There is a limit to what they can do in the event of a combined supply and demand shock.
