We are in the second year with covid-19. And what we’re seeing is that it’s really something that’s unprecedented. We’ve seen huge drops in consumer spending, which in turn has impacted small businesses, which in turn has impacted employment. It’s really unique in the sense that it doesn’t look like previous recessions. When we look at who’s been hit hardest, one thing we see is that consumer spending has dropped precipitously, especially right after COVID cases started going up in early March. But something we saw is that the drop in consumer spending was most extreme with high-income individuals. So it was high-income families who really stopped spending. And in part, this is because high-income families can self isolate. They can work remotely. And they’re the ones who are really not going to their local restaurants, local bars, events, and local small businesses.
You are not alone in the crises
If you’re worried about the economic toll of the coronavirus crisis, you’re not alone. There is no clear forecast, and each country’s experience will be different. We all know is that a steady flow of money, goods, services, and the people to make them flow is essential to a healthy economy, and that flow is severed right now by lifesaving stay-at-home orders. Recession is inevitable, but what kind of recession it will be and what recovery might look like is still unclear.
How economic jolt can be monitored
It can be viewed by determining how hard a crisis hits the supply side of an economy. That’s an economy’s inputs, capital, like machinery, factories, software, labor, or workers plus productivity. When the heart of the supply side is hit the more credit is interrupted, meaning less money is injected in the form of loans to businesses and individuals to fuel investment, and the more difficult it is for productivity to recover. For more exciting stuff please subscribe to our Facebook Page
From best to worst, we can use the V, U, and L recession shock shapes
The V shape is a one-time dip. If credit can continue to flow, productivity and labor are less affected which means the growth dips but recovers to its pre-crisis level and rate.
The U shape is much more costly in this Credit flow is disrupted, and growth drops precipitously, never rebounding to its pre-crisis path.
The L shape is the worst. Credit is severely disrupted not once, but perpetually, and there is very little new investment. This economy never recovers its prior output path, and the rate of growth also declines. The crisis leaves permanent structural damage to the economy’s supply side.
These examples represent crises that started in the financial sector, disrupting credit flow and thus, capital growth. We have some off-the-shelf policies for dealing with these. However, we are now in uncharted territory with a double risk of a financial system shock and an epic freeze of the real economy, the households, firms, and government that deliver real, physical goods and services.
Countries have no existing playbook for dealing with this double shock. Months of necessary social distancing raises the risk of both types of problems, which can feed off each other in dangerous ways. For example, a prolonged crisis can drive up real economy bankruptcies of everyday people and firms, making it harder for financial systems to manage. And a financial system crisis would starve the real economy of credit, which could cripple investment and ultimately growth. In this combined crisis, capital does not grow, pushing the economy towards a U shape, which is not good. For more exciting stuff please subscribe to our Facebook Page
Can head off a U or L-shaped recovery and lessen the intensity of the crisis?
Primarily, Innovation. On the medical side, vaccines, treatments, and capacity innovations are needed to save lives and end the economic damage caused by social distancing. On the economic side, in addition to a vigorous and efficient policy response, we will need policy innovations. For example, in the US, the $2 trillion stimulus bill is just a start. We will need innovative ways to deliver that money to those who need it since never before have policymakers had to help such large numbers of firms and households. For example, the so-called discount windows that allow unlimited access to funding for the financial sector could be replicated for households and firms in the real economy so that they can stay afloat. Zero-interest bridge loans to households and firms, a moratorium on mortgage payments for residential and commercial borrowers, are potential solutions that could help make a real difference. The economic goal is to keep our shock shape closer to and V and further away from a U or an L. Speedy, well-executed medical and policy innovations are our best hope to save the most lives and avoid permanent economic damage.