In 2020 global growth looks set to post its first negative result since the depths of the Global Financial Crisis and may even prove to be the weakest year of global growth in living memory. Unemployment rates are rising fast, underlining the widespread social harm.
Two things make this recession quite unlike any I’ve seen before. The first is the speed of the contraction in activity and the weakness in markets that has come with it. Secondly, this is not a recession borne of a prior build-up in economic imbalances. As regular readers will know, none of our traditional recession indicators have been flashing red, making this a classic ‘Black Swan’ event. The reason asset markets have taken this shock so hard is that many indicators were improving well into February. Shocks from outside the financial system are much harder to quantify and value in asset prices.
None of our traditional recession indicators have been flashing red, making this a classic ‘Black Swan’ event.
The deterioration in the economic outlook has been marked by significant and widespread policy easing across both the developed and developing world. Central banks have cut interest rates, and implemented or expanded asset purchase programmes. Indeed, the most recent multi-trillion dollar commitments by the US Federal Reserve (the Fed) have led commentators to note that in effect, the Fed now “controls interest rates and the broad bond market” for the first time in history.
As we have discussed many times before, given the lack of progress on monetary policy normalisation since the Great Recession, fiscal stimulus has also been widespread, though the quantum has varied from country to country. The lack of prior economic imbalances suggests that while the recession will be deep, the period of contraction will be relatively short – perhaps it’s better to describe this as more of an economic disruption or dislocation than anything else.
The pace at which activity resumes will be determined by the pace of the spread of the virus and the extent to which various economies re-open for business. The best example of this is here at home where it seems likely we will move gradually back down through the various alert levels with a gradual resumption of economic (and other) activity as we move through the levels. Of course, this path assumes sustained improvement in infection prevalence – any pattern of an initial apparent virus retreat followed by a second-wave resurgence in cases would be of graver concern.
So while the length of time economic activity contracts, we expect two to three quarters at most with most of the damage done in the current June quarter, and don’t expect a sudden bounce back to pre COVID-19 levels. We also need to bear in mind that it is not only the economic activity level in New Zealand that will be a decisive factor, but how well our major trading partners manage their own containment and recovery processes.
Indeed, recovery will be hampered by the extent of business failures during the shut-down. One characteristic of recessions is that clearly not all firms survive. The positive spin on that is that marginal firms fail during the recession, freeing up resources for new firms to emerge during the recovery.
We have not had a recession in more than 10 years as central banks all around the world have acted aggressively to stamp out even any hint of economic weakness. That has us concerned about the quantum of business failures we may see out of the current disruption in activity. For firms that went into the lock-down in an already fragile state, fiscal support may not be enough to save them. Mergers between firms out of necessity will become common across many sectors of the economy, as occurred in the financial sector during the severest phase of the GFC. This is a slow process.
That all means that while the drop in economic output and the rise in unemployment have been very sharp, the recovery back to pre-lockdown levels will take longer as demand AND supply will likely be constrained for some time. So while the drop in activity has been quite unusual in its scale and pace, the recovery may look more like a traditional recovery from recession.
If that is correct, we might start to see some outcomes that have been missing in the period of growth since the GFC. Depending on the relative extent of damage to supply and demand, we may see some inflation start to emerge. And given the way in which we are all now having to embrace technology, the recovery might come with gains in productivity.
But there are also risks. In particular, we are concerned about the prospects of a prolonged period of higher unemployment and implications for the housing market. Consumer debt loads are historically high, and though mortgage servicing is aided by low interest rates, an unemployment spike would be problematic for many borrowers.
Our biggest concern since the Global Financial Crisis has been the lack of ability for monetary policy to respond to the next crisis. That concern has only been alleviated by the fact that many countries had at least some room to move on fiscal policy, though today we worry about any meaningful progress in achieving a cohesive regional Eurozone fiscal response.
As we come out of this period of extreme weakness, there will be a need to normalise monetary policy from even more extreme levels, but also to restore fiscal balances to more sustainable levels. In New Zealand we are expecting Crown net debt levels to rise from around 20% of GDP to 45% over the period ahead. Getting that back under control to prepare for the next crisis will require spending restraint at some point. Some countries may also need to consider higher taxes of some form. These are both long-term pieces of work leaving the global economy vulnerable until fiscal buffers are re-established.
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