With a Great Depression sized contraction likely in the second quarter of 2020, the crucial questions are how long it will last and the shape of the recovery.
On Tuesday, the Dow Jones Industrial Average enjoyed its highest single-day percentage gain since March 1933. Back then, the US economy was on the brink of returning to growth after the slump that had begun in 1929. Tuesday’s rally is unlikely to herald a recovery from the unique form of Great Depression we face today, however.
As it becomes clearer to policymakers that COVID-19 threatens to overwhelm healthcare services if left unchecked, more governments have switched from advocating social distancing to locking down their economies by forcing non-essential businesses to close and people to stay at home.
This shift in approach has significant economic, not to mention social, consequences. It is now inevitable that second-quarter GDP numbers around the world will confirm a massive near-term contraction, although there is still a wide range of estimates of the scale of the initial decline.
Some recent forecasts from major investment banks suggest that, even incorporating the latest shutdowns, the initial contractions in output will only be of around the same magnitude as the global financial crisis. Yet a figure as high as a 50% drop (not annualised) for the US has been mentioned by James Bullard of the Federal Reserve.
There is even greater uncertainty around the timing of the rebound, its speed and how far away from normal the world economy settles a few quarters after the virus has eventually been contained.
In our view, there are three potential scenarios. Each reflects a steep initial fall in output but, amid the gloom, there are still some paths to recovery.
In Scenario 1, aggressive containment for several weeks globally brings the virus quickly under control. These measures – from the mandatory closure of many businesses to restrictions on personal movement – would nevertheless still result in a year-on-year fall of around 10% in global output for the second quarter of 2020. This would be more than twice as bad as during the global financial crisis.
However, China shows that it is possible to contain the spread of the virus and re-open an economy. If the rest of the world follows the same timeline, this would begin from May onwards. Crucially this assumes no significant new outbreaks. At the same time, the huge response from monetary and fiscal policy acts as a harness to limit the damage and then slingshot the economy forwards.
While monetary initiatives – such as the Federal Reserve announcing unlimited quantitative easing, further lending programmes, and corporate bond purchases in both the primary and secondary market – can stabilise the financial system, the fiscal stimulus currently being introduced across the world could cover a good proportion of the lost income in the shutdown phase.
Such stimulus will primarily be in the form of transfer payments so can’t stop the initial collapse in GDP, but can prevent the longer-lasting damage to balance sheets and personal finances after restrictions are lifted. This could involve huge swings in global unemployment rates, with an initial spike and then a reversal as work resumes, with unemployment returning to near normal levels by the end of 2021.
Overall, under this scenario global growth would be around -3% in 2020 (roughly the same as during the financial crisis for the year as whole) and +8% in 2021.
Scenario 2 is less positive. In this case, containment strategies are lifted too early and have to be aggressively re-introduced or they are gradually lifted in the second half of 2020 but additional restrictions then have to be brought back to tackle renewed outbreaks. The damage would already have been done in terms of a significant rise in unemployment and bankruptcies; unemployment eases but remains high in 2021, i.e. similar to one year after the financial crisis. We then either learn to cope with seasonal outbreaks or a vaccine is found in 2021.
Under these conditions, global growth would be around -10% in 2020 – a contraction more than three times greater than in the financial crisis for the year as a whole – but there would be a partial snap back in 2021 of +8%.
The world would have lost three years of output growth in this scenario – we would be back to early 2019’s GDP levels by the end of 2021, so running 5-10% below full productive capacity – but that is preferable to the multi-year slump of the Great Depression.
Scenario 3 is the most concerning. Here, heavy restrictions on individuals and businesses remain in place through 2020; any attempt to relax them is quickly reversed as the virus flares up again and has a mortality rate that is higher than expected. A huge rise in unemployment and bankruptcies would undermine confidence, while monetary policy is exhausted and fiscal authorities become reluctant to add further to their already massive deficits.
There would be no significant recovery in 2021, no vaccine, and no herd immunity. Needless to say, this scenario would have many other negative social, financial and political consequences. Economically, we would associate it with a year-on-year fall in global output in excess of 20% and an annual average contraction of 15-20%.
We believe Scenarios 1 and 2 are more likely, but there is a risk of us ending up in Scenario 3.