Stock markets around the world continue to twirl wildly as investors consider significant downside risks to a new baseline scenario of a global recession later this year and into 2021. Despite the formulation and deployment of significant policy responses economic policy to the spread of the coronavirus, the United States and the European Union will both experience a recession this year, with China’s growth slowing significantly. The UK, Japan and South Korea are all responding to their own outbreaks and are also at risk of recession. These economies together account for more than 70% of the world’s gross domestic product.
Governments and central banks around the world have embarked on an initial round of measures to mitigate the anticipated economic impact of the spread of the virus. The International Monetary Fund (IMF), the World Bank and other international bodies provide their own tools, such as the IMF’s Rapid Financing Instrument and Rapid Credit Facility for countries with balance of payments problems. . A first global coordination on economic policy is also underway through the Group of Seven (G7).
Stock markets continue to produce single-day swings that are historic by any measure. One of the main reasons for this is that the public health goal of “flattening the curve” to ensure health systems are not overwhelmed implies an extended period during which social distancing is desirable. As a result, the complete paralysis of large parts of the economy could well last for months.
With many economic forecasts now predicting a global recession again this year, the uncertainty surrounding this consensus is significantly higher than it would be in normal times. Along with the uncertain duration of the economic downturn, downside risks preventing investors from calling the stock market bottom include a prolonged depression with mass unemployment, a financial crisis emanating from large corporate bankruptcies that cripple the system bank, and galloping inflation due to a very accommodating monetary policy. A positive scenario to consider is a faster-than-expected development of a treatment drug and/or vaccine that would bring increased visibility into the ultimate pathway of the virus and radically improve clarity in the economic environment.
Central banks deploy several tools to deal with these circumstances. Many have lowered their key interest rates to historically low levels, although the necessary public health policy response to the pandemic significantly lessens the impact of low interest rates, as consumers are less likely and/or unable to spend more. Central banks can also intervene in funding markets that are frozen or not functioning normally, because the Federal Reserve (Fed) in the United States did so on March 17 when he ensured businesses continued to have access to short-term credit.
The world’s major central banks are also making more aggressive use of discount windows and other forms of direct and indirect provision of credit to the financial and real sectors of the economy, such as changes made by the European Central Bank (ECB ) to its program longer-term refinancing operations in the order support bank lending to small and medium enterprises. Most major central banks have resumed or expanded their asset purchase programs, including $700 billion of US Treasuries and mortgage-backed securities by the Fed and $135 billion in corporate and government bonds by the ECB. Finally, the Federal Reserve, over the weekend of March 15-16, took steps to bolster global dollar liquidity through existing swap lines with the world’s other major central banks.
Efforts announced or being drafted by major governments such as Germany, UK, US and others focus on extending credit to the corporate sector to support businesses of all sizes during the period of disturbance. US examples include the proposed secured facility of $50 billion for the airline industry and $150 billion for other affected business sectors. Similarly, Germany’s state-owned bank KfW has been authorized to lend over $600 billion and the UK has announced a $400 billion program of state-guaranteed loans. Most of the other advanced economies affected, including Spain, Japan, France, Italy and Canada, have announced similar programs. When assessed against the size of the economy, the (proposed) policy responses in the US, Spain, Germany and the UK are already approaching or exceeding efforts during the global financial crisis of 2007-2008 and/or the subsequent crisis. European debt crisis. In particular, the trillion dollars the United States proposes to spend initially is nearly identical in proportion to the size of the Troubled Asset Relief Program (TARP) in 2008.
Discussions within the European Union on the deployment of the European Stability Mechanism (ESM, which has more than 430 billion dollars of capacity) are underway. The ESM was created by and for the members of the Eurozone, so EU member states not using the Euro would not benefit from any use of the ESM.
Finally, important measures are proposed and implemented at consumer level. US policymakers are offering direct payments to taxpayers on a sliding scale. In Italy, the UK and elsewhere, tax date reporting delays, mortgage and loan repayment holidays and statutory sick pay have also been part of the government response.
Policymakers around the world have, in different terms, signaled their commitment to take further action if needed. As markets assimilate the progress of the epidemic and the measures announced, additional country-specific programs and international efforts – for example through the Group of Twenty (G20) – will likely become necessary in the coming weeks.
Bart Oosterveld is a Nonresident Senior Fellow at the Atlantic Council and Special Advisor for ACG Analytics.