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A pause that upends: How the coronavirus disrupts the present and alters the future

by  Subitha Subramaniam  |  08 Apr 2020


It has been just a few months since the coronavirus emerged in a wet animal market in Wuhan, China. Since then, it has been detected in almost every country in the world. With the virus overwhelming health systems, policy makers have chosen to pause activity and bring economies to a virtual standstill. We have encountered shocks and pandemics before – but never one that has elicited such a draconian response.

When lockdowns and social distancing fade into distant memory, what will the world look like? Will households resume their daily routine? Will business go back to normal? Or will the virus leave a lasting impression on the world?

Flashback to the Roaring Twenties?

The Corona shock is fundamentally different to any other we have encountered over the past two decades. The financial crisis of 2008-9 originated in a single sector – the housing market – and the banking sector amplified its losses. The recession in 2000 was due to the deflation of a valuation bubble, and this had little lasting impact on the real economy. The 1990 recession hit the US hard, but the asynchronous world carried on.

By contrast, the corona slowdown has more in common with the Great Depression of 1929 – 1933: like today, unemployment rose dramatically across multiple sectors of the economy. In 1930, President Hoover exacerbated the downturn when he implemented the Smoot Hawley tariffs. Today, border closures and travel restrictions, introduced to stem the transmission of the virus, will also serve to amplify the magnitude of the recession.

Pre-corona economic conditions were also not dissimilar to the Roaring Twenties:

  • Both were periods of rapid innovation which led to spectacular increases in the stock market
  • Both were low real interest rate environments
  • Both periods saw an explosion in the use of leverage: household and corporate debt levels rose sharply
  • Both were periods of synchronised global growth.

Lessons have been learned

There is, however, a crucial distinction between now and 1929: today’s policymakers are acutely aware of the policy mistakes in 1929 that turned a deep recession into a global depression. They are determined not to repeat them. This belief underpinned the US Federal Reserve’s (Fed) aggressive response to the stock market crash of 2000 and the financial crisis of 2008. It is also driving their actions today.

Faced with an unprecedented contraction, the Fed has shown its willingness to use every tool at its disposal to keep the financial system working. The Fed not only deployed the playbook from 2008 but also pushed further into taboo areas: lending to corporates and small and medium sized enterprises. The result has been swift, coordinated and all-encompassing action from both central banks and politicians.

Will the medicine work?

Despite the authorities’ best effort to cushion the blow, asking the world to lock down and stay put will dramatically shrink growth. Our calculations suggest that global growth in US dollars can decline from at best -1.8% to a worst-case scenario of a -5.5%.

Compared to our pre- Covid-19 growth estimate of 2.5%, this represents a dramatic turn of events. Importantly, this shows that the global economy will be in a far worse position than in 2008/09, when it contracted by -1.7%.

It could be worse

It should be said that these estimates are based on the direct impact to the economy. We have not yet accounted for the knock-on effects. These include:

  • Higher default rates for corporate debt due to tighter credit and funding markets, which could lead to banking system stress and more layoffs;
  • Defaults in consumer loans due to rising unemployment – already a major concern this week after the US recorded its single biggest weekly rise in unemployment claims since records began in 1967; and
  • A negative impact on global growth as measured in US dollars as a result of sustained US currency strength.

While there are severe risks to the outlook, we believe that aggressive policy action will likely have limit these feedback loops. Monetary policy will continue to intervene, ensuring that the plumbing of the financial system keeps running smoothly. Numerous interventions in money market, commercial paper and treasury markets are already underway to prevent a cash crunch from turning into a significant credit crunch.

Similarly, fiscal expansion aims to ensure that the broader impact of rising unemployment on consumer confidence is contained. Measures such as the direct transfer of money to households and loan guarantees to businesses are governments’ ways of keeping the economy functioning through this cash crunch.

It may be difficult to keep up with the torrent of measures being announced, but all of these are aimed at keeping the financial system from seizing up and providing a safety net for businesses and households. Without this action, the contraction would undoubtedly be far deeper and more prolonged.

After the shock

We are working on the assumption that Covid-19 is a temporary shock to the economy, one that dissipates as soon as an effective vaccine is found. However, it is safe to say that after the worst of the pandemic subsides, the world will not return to ‘business as usual’.

The sheer scale and severity of the disruption to activity will have a lasting impact on balance sheets of households, businesses and the government. The world that emerges from the crisis will be one that is impaired as savings would have been depleted and debt loads increased. Most noticeably, the government debt will have increased to such high levels that Central Banks will need to underwrite this expenditure for years to come.

Yet our world may also emerge reshaped in other, more positive ways. The need for companies to facilitate home working on a grand scale may lead to greater flexibility in the future, benefiting workers in the long term. As our social and work lives move online, digital opportunities abound. And costly fiscal could finally inject some much needed long term thinking into how to spend the public purse,transforming public services.