Coronavirus and the World Economy: What to Expect?

The extreme medical emergency many economies are facing has led to an unprecedented policy response.

Pandemic update

The virus continues to spread rapidly on both sides of the Atlantic. In Europe, the total number of confirmed infections has risen by 61% within three days to 150,000, as of March 22.

From a lower level, the United States is following Europe, with a 185% surge to 27,000 during this period.

Unprecedented economic policy response

Policy makers are scaling up their responses, imposing tighter restrictions on daily life and initiating ever bigger support packages on both sides of the Atlantic in rapid succession.

To respond properly to the coronavirus crisis, previous economic policy taboos, including those on the proper role of the government in the United States and of fiscal rules in Europe, are being ditched or suspended as required.

The unprecedented policy response will prevent a financial crisis that would otherwise exacerbate the recession while the world tackles the extreme health emergency.

The main point is this: Economies will rebound.

Worse than the post-Lehman slump

At least for 2020 and the months March to May, economic data will probably show a contraction not seen before in peacetime. The plunge may be deeper or last longer.

All European countries will incur huge budget deficits in a year when GDP might fall by 5% or more. In Italy, Spain and a few other countries, the deficits may exceed 10% of GDP.

Back to pre-Corona GDP within two years after the low point

Near-term, the risks are heavily tilted to the downside. But the more activity has to be switched off now, the more will be switched on again at some point thereafter, probably in a step-by-step process.

As a rough guess, GDP can get back to roughly the pre-Corona level within two years after the trough in the advanced world — whenever and at what precise level that trough may be.

What about the rebound phase?

The rebound may be more muted as households and companies hold back on spending as they are still scarred by the experience. But the rebound may also be stronger.

Most of the monetary and part of the unprecedented fiscal stimulus will still be in the pipeline if and when the shock to the real economy starts to ease. Pent-up demand may add to that for many goods and some services.

Governments saving companies?

As one part of the rescue measures, we will see direct injections of public money into some companies.

One interesting side effect of this is that such injections would re-distribute some of the gains from a future rebound in company values, as they will be expressed in the equity markets, from current owners of equities (often holders of pension plans) to taxpayers.

Debt migration? Yes. And expect a degree of “Japanification“

Due to “whatever it takes“ policy responses, a significant part of the costs of the pandemic will turn into public debt over time. It will also partly end up on central bank balance sheets.

Interest rates that will likely be much lower for much longer after the corona recession. This will make the debt burden bearable in most cases.

Expect a degree of “Japanification“ of many Western economies in this particular sense.