The next recession, much like in the 70s, will be driven by a supply shock
But policymakers and altogether too many economic commentators fail to grasp how the supply component may make the next global recession unlike the last two. In contrast to recessions driven mainly by a demand shortfall, the challenge posed by a supply-side-driven downturn is that it can result in sharp declines in production and widespread bottlenecks. In that case, generalized shortages – something that some countries have not seen since the gas lines of 1970s – could ultimately push inflation up, not down.Admittedly, the initial conditions for containing generalized inflation today are extraordinarily favorable. But, given that four decades of globalization has almost certainly been the main factor underlying low inflation, a sustained retreat behind national borders, owing to a COVID-19 pandemic (or even lasting fear of pandemic), on top of rising trade frictions, is a recipe for the return of upward price pressures. In this scenario, rising inflation could prop up interest rates and challenge both monetary and fiscal policymakers.
That 1970s Feeling
By: Kenneth Rogoff – Harvard University
If it is mainly a supply shock what should central banks do?
Alternatively, the central bank can observe the drop in economic activity (lower Y) and conclude it needs to offset this by increasing aggregate demand and hence need to ease monetary conditions. This is essentially what central banks did in the 1970s when they reacted to lower structural growth rates and numerous oil prices shocks. These shocks clearly were negative supply shocks which didn’t warrant an easing of a monetary response.Hence, the textbook on this is clear – central banks shouldn’t try to shift the AD curve when the AS curve moves. Rather the central bank should singlehandedly focus on keeping nominal demand (the AD curve/NGDP growth) on track.
The scary risk that central banks will turn the ‘corona shock’ into a global recession
By: Lars Christensen – Stellenbosch University
What if it is both a supply and a demand shock?
If people start worrying about getting the disease sufficiently to cut back on this social consumption, the economic impact will be more severe than any numbers discussed so far. One reason it is severe is that it is partly a permanent loss. Maybe you will have a few more meals out once the pandemic is over to make up for what you missed when you stayed home, but there is likely to be a net fall in your consumption of meals out over the year. What I realised when I did the analysis was just how much of our consumption was social.
This is why the biggest impacts on GDP occur when we have people reducing their social consumption in an effort not to get the disease. However falls in social consumption do not scale up all scenarios by the same amount, for the simple reason that supply and demand are complimentary. If school closures and people taking more time off work increase the size of the supply shock, the demand shock has less scope to do damage.
The economic effects of a pandemic
By: Simon Wren-Lewis – University of Oxford
How is Hong Kong dealing with the demand shock
The Hong Kong government is about to start its fourth experiment with helicopter money: Hong Kong permanent residents aged 18 and above will each receive a cash handout of HK$10,000 (US$1,200) in a HK$120 billion (US$15 billion) relief deal rolled out by the government to ease the economic burden on individuals and companies. These handouts will be financed with tax revenues as the Hong Kong government will draw upon its substantial “fiscal reserve” of HK$1.1 trillion.
…Hong Kong’s planned cash handouts have already been paid for, in full, by its taxpayers—and with plenty to spare. The handouts are nothing more than a government income-redistribution scheme, with no monetary policy implications whatsoever. Those looking for a test of the theory of helicopter money, or for an outbreak of Hong Kong hyperinflation, will have to wait longer for them. With a little luck, they’ll wait forever.
Handouts, Helicopters, Hong Kong Dollars, and Hogwash
By: George Selgin – CATO Institute
