Calls for policymakers to act to prevent ‘doom loop’

Disruptions caused by the coronavirus outbreak that originated in China and is now spreading through the rest of the world are driving the global economy closer to a recession, triggering calls for fiscal and monetary intervention.

Capital Economics cut its growth forecast by 0.4 percentage points to 2.5 per cent for 2020, in what the IMF considers recession territory. But Jennifer McKeown, head of economic research at Capital Economics, cautioned that if the outbreak became a global pandemic — a state some epidemiologists say has already been reached — the effect “could be as bad as 2009, when world GDP fell by 0.5 per cent”.

Predictions by IMF chief Kristalina Georgieva a week ago that global growth would be hit by just 0.1 percentage points at 3.2 per cent this year already seem out of date. The OECD in Paris will on Monday rush out a new interim forecast, setting out a greater impact than the IMF’s reading, and outline an alternative scenario with what officials describe as “more serious consequences”. 

A global recession in the first half of this year is “suddenly looking like a distinct possibility”, said Erik Nielsen, chief economist at UniCredit.

The question for policymakers is what to do as pressure grows for them to take preventive measures to stimulate the economy. “The ability of the economy to bounce back strongly depends in large part on whether we see effective policy intervention,” said Karen Ward, chief European market strategist at JPMorgan Asset Management.

Some monetary policymakers have argued that coronavirus is a supply shock to the economy — removing workers from their places of employment and components from factories — and therefore makes stimulus ineffective.

Jon Cunliffe, deputy governor of the Bank of England, said on Thursday that since coronavirus was “a pure supply shock there is not much we can do about it”.

Other economists say, however, that it depends on the magnitude of the supply shocks. In a study of a global flu pandemic, Oxford university professors estimated that a four-week closure of schools — almost exactly what Japan has introduced — would knock 0.6 per cent off output in one year as parents would have to stay off work to look after children.

In a 2006 paper, Warwick McKibbin and Alexandra Sidorenko of the Australian National University estimated that a moderate to severe global flu pandemic with a mortality rate up to 1.2 per cent would knock up to 6 per cent off advanced economy GDP in the year of the outbreak.

For policymakers, it is also almost impossible to distinguish between a lack of demand caused by people deciding not to spend at a time of an epidemic and pure supply shocks. 

Chart showing how new daily coronavirus cases are spreading faster outside of China

The point of taking action is “to prevent the supply disruption triggering a doom loop” of weaker supply that in turn leads to lower spending, said Roger Farmer, professor of economics at UCLA.

Fiscal policy would also help pay for necessary medical interventions and boost demand while monetary policy can also help keep demand higher and seek to prevent financial distress among indebted companies, said Olivier Blanchard, senior fellow at the Peterson Institute.

There are signs central bankers and governments are weighing bolder measures:

US

Federal Reserve chair Jay Powell signalled on Friday that the central bank was considering cutting interest rates in response to the “evolving risks” to the US economy posed by the spread of coronavirus.

A statement between meetings is a rare move for the Fed. As recently as Tuesday, Fed vice-chair Richard Clarida had said that it was “still too soon to even speculate” about economic consequences outside of China.

The Department of the Treasury meanwhile has been reluctant to speak about the risks posed by the virus on growth, or to commit to a response. In a call with reporters before Mr Powell’s statement, a Treasury official said that the most likely outcome was still “V-shaped” — a shortlived hit, contained within a quarter, followed by a sharp recovery.

Eurozone

Even before coronavirus started to upset the world economy, the eurozone had slowed to its weakest growth rate since the bloc’s sovereign debt crisis. Now with the disease reaching Europe, economists fear more disruption to supply chains, trade and tourism.

The European Commission this week earmarked €232m to help contain the disease. On Sunday, Italy — the European country most severely hit by coronavirus — has announced a €3.6bn stimulus package, saying it would seek authorisation from Brussels to widen its budget deficit this year.

The European Central Bank has yet to signal any imminent intervention. Its president Christine Lagarde said last week that the outbreak was not yet at the stage where it would have a lasting impact on inflation and, therefore, require a monetary policy response. The central bank whose next meeting to decide monetary policy is on March 12, has forecast eurozone growth will slow from 1.2 per cent last year to 1.1 per cent in 2020, before rebounding to 1.4 per cent next year.

Japan

The coronavirus has hit Japan just as the government was seeking to implement a new stimulus package to help mitigate a damaging rise in consumption tax.

Most analysts have already pencilled in a technical recession after the tax rise prompted a 6.3 per cent fall in annualised output in the fourth quarter of 2019.

But the widespread assumption was until recently that there was little risk of Japan suffering a true downturn in demand. “There hasn’t been any big change in our expectation of gentle growth in the Japanese economy,” said Bank of Japan governor Haruhiko Kuroda at a press conference after last weekend’s G20.

If there is a big hit to demand, the BoJ has little room to respond, with overnight interest rates at minus 0.1 per cent and 10-year bond yields capped at zero. It could lower those rates further, or increase its asset purchases, but the central bank expects little benefit and some costs to financial stability.

That leaves fiscal policy as the main tool for action. But the government has just finished legislation on a supplementary budget for the fiscal year to March 2020 and it is likely to be months before it can consider any further measures.

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