Some (almost) knowns

BY Ian Stewart | tweet IanStewartEcon   /  6 April 2020

A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK.

The global financial crisis of 2008-09 ended a period of good and predictable growth for the world economy. In its wake we have seen elevated political and economic uncertainty, and weaker growth. Yet today that looks like a golden era. In just a month, the world has been pitched into a deep downturn, one that the head of the International Monetary Fund says will be “way worse” than the global financial crisis. The uncertainties are legion. So what can one say with a reasonable degree of confidence? Here are four, very subjective ones, that occur to me.

First, growth in the Western world in the second quarter is likely to contract at record rates. The speed of the decline is astonishing; for most countries the loss of GDP in the current quarter is likely to exceed that seen over the entire financial crisis. Last Friday we held a virtual discussion with, and polled, a group of around a dozen economists from finance, government and consulting. These are personal views on the day, not ‘house’ forecasts, but they are revealing. The range of views on second quarter UK GDP were extraordinarily wide, from a contraction of 0-5% to one of 21-30%. The median forecast was for a contraction of 11-15%. This would be more than four times the scale of the largest previous decline in modern times, in early 1974. This was at the time of the ‘three-day week’ when a miners’ strike and a Middle Eastern oil embargo led to energy shortages and power cuts.

Second, the actions of central banks and governments to support the economy, are radical and on enormous scale. Echoing European Central Bank (ECB) president, Mario Draghi, at the height of the euro crisis, the message from policymakers is that they will ‘do whatever it takes’. The US Federal Reserve and the ECB have gone further than in the financial crisis, saying, they will buy bonds without limit. Governments are writing blank cheques with generous new income support schemes whose costs depend on demand. The old economic rules are being trampled, with a massive expansion of government spending, intervention in the economy and debt.

Third, the policy response has helped arrest the near-panic in financial markets seen in the middle of March. This is tentative and changeable. Still, a number of measures of financial risk have eased since March’s turmoil. Equities and corporate bonds are off their lows. The spread between Italian and German bond yields, a measure of fears about Italian debt, has narrowed. The VIX index of equity volatility has fallen back somewhat. The US Treasury market, which last month risked becoming illiquid as nervous investors sold even this safe asset in search of cash, is in better shape and yields have resumed their downward trajectory.

Fourth, bad though this crisis is for Western countries, it poses even greater risks in emerging economies. Underlying levels of health and nutrition are generally poorer, public health provision often limited or rudimentary. The lack of welfare systems, and limited ability to borrow internationally, means that emerging economies may struggle to support household incomes. The sort of quarantine measures that slow the path of the disease work best in relatively affluent societies, ones with good social conditions and strong institutions.

The list of unknowns is far, far longer. How fast can countries ramp up testing and ICU capacity? When will we be able to ease the lockdown? What sort of measures will be needed to suppress subsequent waves of the virus? When will a vaccine become available? Will increased support for households and businesses arrive in time? Are we heading for debt monetisation, with central banks directly financing government spending? Where is inflation going?

We discussed some of these questions with other economists on our call last Friday. Here’s what they thought. Most thought the maximum period the UK could sustain the current lockdown would be 3-6 months; no one thought it could last longer. UK growth is expected to revive sometime in the second half of this year, with views split between the third and fourth quarters. The median view was that GDP would rise by 3% in the third quarter, far less than the 11-15% contraction expected in the second quarter. So while they see growth coming back this year, they don’t expect a rapid bounce back. Indeed, most thought that the level of UK GDP would not return to the previous peak until 2022.

This all, of course, depends on the path of the virus and the duration of the lockdown. On Saturday a prominent UK government adviser, Professor Neil Ferguson of Imperial College, said he expected the UK epidemic to plateau in the next week to ten days. He suggested that, if people adhere to the rules, it might be possible “in a few weeks’ time” to move to a regime in which social distancing was eased slightly, and in which testing and tracing played a greater role. Everything, Professor Ferguson emphasised, depends on peoples’ behaviour; and any easing of restrictions would not represent a “return to normal”.

The global economy is in the early stages of a major downturn. The level of economic and financial uncertainty is exceptional even by the standards of the financial crisis 12 years ago. Economic views, as we found on Friday, vary widely; they will change as the data and facts change. But in the West a strategy has emerged: suppression and tracking of the virus, increasing health capacity and maintaining the cohesion and productive capacity of nations. These criteria will measure our progress in the battle against the virus.


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