The global economic crisis sparked by the coronavirus pandemic will have ramifications stretching well beyond one of the deepest world recessions in modern history. The post-crisis landscape will see a sharp intensification of the inequality debate, accelerating economic nationalism and pressures on the institutions of macro-economic policymaking.
The scale of the immediate shock is hard to fully comprehend. Fitch Ratings estimates that GDP has fallen by 20 percent in countries that have imposed full lockdown policies, including the US. This is equivalent to the peak to trough decline in US real GDP in the Great Depression. The startling difference is that this has just occurred in the space of a few weeks compared to taking nearly three years between December 1929 and autumn 1931. The overwhelming speed of the collapse has seen almost instantaneous job losses, on an extreme scale. GDP in the US and Eurozone is likely to fall by 3 percent to 4 percent this year, possibly by 2 percentage points more if lockdowns have to be extended substantially. World GDP is set to drop by 2 percent in 2020.
The size of the shock alone will lengthen the duration of its impact. Assuming that the health crisis eases in the second half of the year, the post-lockdown recovery will be dampened by labor market dislocation, corporate bankruptcies, and the tightening of credit conditions. Economic policymakers are doing all they can to minimize collateral damage through the unlimited provision of liquidity, higher public spending, regulatory forbearance, the rollout of huge credit guarantee schemes, and temporary employment subsidies. Policy stimulus will arguably gain more traction once the health crisis has subsided. But even allowing for this—and for some re-profiling of consumer durables spending from the first half of the year—pre-crisis levels of activity are unlikely to be reached until the second half of next year (and later if the near-term shock proves to be larger).
The post-crisis landscape will see a sharp intensification of the inequality debate, accelerating economic nationalism and pressures on the institutions of macro-economic policymaking.
The impacts will be felt far beyond this, though. With the shock taking a particularly heavy toll on jobs in service-sector industries where pay levels are lower than average, the inequality debate in the US will become more intense. In recent years, this debate has fostered a backlash against globalization that seems almost certain to be amplified. A renewed escalation in US-China trade tensions in the aftermath of the crisis is a high risk, and multi-national corporations are likely to reconsider their exposures to global supply-chain vulnerabilities in light of China’s manufacturing shutdown in February. Lasting restrictions on international travel and the introduction of new national regulations to enhance biosecurity are likely to go hand in hand with a rise in economic nationalism, dampening world trade, and encouraging the “re-shoring” of production.
But some of the biggest challenges will be felt in macroeconomic policy institutions. The enormous fiscal costs of the crisis will see government funding needs to be elevated throughout the medium term, particularly against a backdrop of limited progress in reducing public debt after the global financial crisis. This could complicate any desire by central banks to exit from the emergency balance sheet expansions now underway. Crisis situations often entail some blurring of the lines between fiscal and monetary policy, but the risk is that this becomes a more permanent feature amidst increasingly shrill calls for helicopter money and the application of modern monetary theory.
Central banks will doubtless seek to guard their independence, but with financial markets having also become highly accustomed to central bank liquidity support, there is a growing risk of fiscal and financial dominance of monetary policy. This may not matter in the short- to medium-term as the recession and falling commodity prices push down on inflation, and many point to the experience of Japan as a sign that much larger central bank balance sheets will not cause inflation. But Japan has a number of unique features, including its high saving rate, external strengths, labor market structures, and a relatively closed domestic financial system. De-globalization will reverse some of the disinflationary forces in goods markets seen in the first two decades of this century. In the very near term, consumers are also bound to experience some significant price increases in the midst of the current crisis as supply shortages mount. Certainly, some central banks may find that all out liquidity expansion, if sustained for too long, could start to weigh on public confidence in the currency as a store of value.