Insight
Bold policies needed to counter the coronavirus recession by Christian Odendahl and John Springford 10 March 2020
The COVID-19 crisis is serious, and will have severe economic consequences. But if matched by aggressive action from fiscal and monetary authorities, the economic fallout is manageable. The 2008 financial crisis was a global economic catastrophe. Millions of people lost their jobs, their homes, their savings or their businesses as banks collapsed and credit dried up. It sparked the euro crisis, from which countries slowly recovered, with many experiencing a lost decade. Some fear that the outbreak of COVID-19, which is very likely to become a global pandemic, will be just as bad. But while the economic disruption caused by the epidemic looks likely to be sizeable, the long-term effects on the economy will be far less severe than the financial crisis, as long as governments act quickly to contain the economic fallout. Financial crises are, in essence, collapses in trust in the financial system. Creditors fear that they are exposed to losses and seek safer assets, which in turn leads to shortages of liquidity. Riskier businesses have difficulty borrowing, rendering some insolvent. Tighter financial conditions also lead households and firms to cut spending. Thus the 2008 financial crisis became an economic one: demand collapsed and international trade fell 15 per cent from the peak to the trough as the collapse in credit rippled through the global economy. Governments and central banks intervened, but failed to support private sector spending sufficiently, whether through stimulus or a rapid restructuring of the banking system. The economics of the coronavirus epidemic is different, but some of the fallout will follow a similar pattern. Fears of contagion and government action to contain the spread of the disease have led to a global supply shock, especially in manufacturing. Factories and offices are closing or reducing operations in order to protect workers. As the infected isolate themselves – and others reduce social contact – they will spend less on flights, in bars and restaurants, and on other social activities. And businesses are facing liquidity problems, with production slowing as workers stay at home, and revenues starting to fall. If the issue of liquidity is not addressed, firms might have to lay off workers or close altogether. This is a major reason why stock markets have been in free fall globally, and government bonds have jumped in value as investors flee to safety. CER INSIGHT: Bold policies needed to counter the coronavirus recession 10 March 2020
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