Coronavirus
pandemic has delivered the fastest, deepest economic shock in history
Nouriel
Roubini
The
financial crisis and Great Depression took three years to play out, this crisis
has taken three weeks. The Greater Depression beckons
Wed 25 Mar
2020 06.00 GMTLast modified on Wed 25 Mar 2020 06.34 GMT
The shock
to the global economy from Covid-19 has been faster and more severe than the
2008 global financial crisisand even the Great Depression. In those two
previous episodes, stock markets collapsed by 50% or more, credit markets froze
up, massive bankruptcies followed, unemployment rates soared above 10% and GDP
contracted at an annualised rate of 10% or more. But all of this took around
three years to play out. In the current crisis, similarly dire macroeconomic
and financial outcomes have materialised in three weeks.
Earlier
this month, it took only 15 days for the US stock market to plummet into bear
territory (a 20% decline from its peak) – the fastest such decline ever. Now,
markets are down 35%, credit markets have seized up and credit spreads (like
those for junk bonds) have spiked to 2008 levels. Even mainstream financial
firms such as Goldman Sachs, JP Morgan and Morgan Stanley expect US GDP to fall
by an annualised rate of 6% in the first quarter and by 24% to 30% in the
second. The US Treasury secretary, Steve Mnuchin, has warned that the
unemployment rate could skyrocket to above 20% (twice the peak level during the
financial crisis).
In other
words, every component of aggregate demand – consumption, capital spending,
exports – is in unprecedented freefall. While most self-serving commentators
have been anticipating a V-shaped downturn – with output falling sharply for
one quarter and then rapidly recovering the next – it should now be clear that
the Covid-19 crisis is something else entirely. The contraction that is now
under way looks to be neither V- nor U- nor L-shaped (a sharp downturn followed
by stagnation). Rather, it looks like an I: a vertical line representing financial
markets and the real economy plummeting.
Not even
during the Great Depression and the second world war did the bulk of economic
activity literally shut down, as it has in China, the US and Europe today. The
best-case scenario would be a downturn that is more severe than the financial
crisis (in terms of reduced cumulative global output) but shorter-lived,
allowing for a return to positive growth by the fourth quarter of this year. In
that case, markets would start to recover when the light at the end of the
tunnel appears.
But the
best-case scenario assumes several conditions. First, the US, Europe and other
heavily affected economies would need to roll out widespread Covid-19 testing,
tracing, and treatment measures, enforced quarantines, and a full-scale
lockdown of the type that China has implemented. And, because it could take 18
months for a vaccine to be developed and produced at scale, antivirals and
other therapeutics will need to be deployed on a massive scale.
Second,
monetary policymakers – who have already done in less than a month what took
them three years to do after the financial crisis – must continue to throw the
kitchen sink of unconventional measures at the crisis. That means zero or
negative interest rates; enhanced forward guidance; quantitative easing; and
credit easing (the purchase of private assets) to backstop banks, non-banks,
money market funds, and even large corporations (commercial paper and corporate
bond facilities). The US Federal Reserve has expanded its cross-border swap
lines to address the massive dollar liquidity shortage in global markets but we
now need more facilities to encourage banks to lend to illiquid but still-solvent
small and medium-size enterprises.
Third,
governments need to deploy massive fiscal stimulus, including through
“helicopter drops” of direct cash disbursements to households. Given the size
of the economic shock, fiscal deficits in advanced economies will need to
increase from 2-3% of GDP to about 10% or more. Only central governments have
balance sheets large and strong enough to prevent the private sector’s
collapse.
But these
deficit-financed interventions must be fully monetised. If they are financed
through standard government debt, interest rates would rise sharply, and the
recovery would be smothered in its cradle. Given the circumstances,
interventions long proposed by leftists of the Modern Monetary Theory school,
including helicopter drops, have become mainstream.
Unfortunately
for the best-case scenario, the public-health response in advanced economies
has fallen far short of what is needed to contain the pandemic and the
fiscal-policy package currently being debated is neither large nor rapid enough
to create the conditions for a timely recovery. As such, the risk of a new
Great Depression, worse than the original – a Greater Depression – is rising by
the day.
Unless the
pandemic is stopped, economies and markets around the world will continue their
freefall. But even if the pandemic is more or less contained, overall growth
still may not return by the end of 2020. After all, by then, another virus
season is very likely to start with new mutations; therapeutic interventions
that many are counting on may turn out to be less effective than hoped. So,
economies will contract again and markets will crash again.
Moreover,
the fiscal response could hit a wall if the monetisation of massive deficits
starts to produce high inflation, especially if a series of virus-related
negative supply shocks reduces potential growth. And many countries simply
cannot undertake such borrowing in their own currency. Who will bail out
governments, corporations, banks, and households in emerging markets?
In any
case, even if the pandemic and the economic fallout were brought under control,
the global economy could still be subject to a number of “white swan” tail
risks. With the US presidential election approaching, the Covid-19 crisis will
give way to renewed conflicts between the west and at least four revisionist
powers: China, Russia, Iran, and North Korea, all of which are already using
asymmetric cyberwarfare to undermine the US from within. The inevitable cyber
attacks on the US election process may lead to a contested final result, with
charges of “rigging” and the possibility of outright violence and civil
disorder.
• Nouriel
Roubini is a professor at NYU’s Stern School of Business and was senior
economist for international affairs in the Clinton White House’s Council of
Economic Advisers. He has worked for the IMF, the US Federal Reserve and the
World Bank.
© Project Syndicate
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