The road to recovery

The 98% economy

The Covid recession is so unusual that historical economic relationships, which underpin most economic forecasts, may provide an unreliable guide to the recovery. Moreover, headline forecasts do not identify the mechanisms through which industry-level unevenness affects aggregate outcomes. This matters because an uneven recovery driven by constraints on supply has different aggregate implications from one that reflects shifts in demand. The pattern of supply- and demand-side disturbances could vary between economies, driving differences in aggregate outcomes even after controlling for industry composition.
[…] Aggregating the industry-level projections suggests that large AEs could face a “98% economy” in the years ahead, with GDP recovering to at best 2% below its pre-crisis trend . The persistent slump in GDP does not reflect a lack of policy stimulus, but rather a lower level of potential output.

What comes next? Recovery from an uneven recession
By: Daniel Rees – BIS

“Excess deposits”

However, there are several reasons why these excess savings may not boost aggregate private demand beyond negative confidence effects. For example, the distribution of deposits may be skewed. If the increase in NFCs’ deposits has been driven by a few large firms that benefitted from the crisis, particularly in the technology sector, excess deposits are unlikely to stimulate future economy-wide investment. Similarly, if the increase in household deposits were mostly driven by high-income households with a relative low marginal propensity to consume, then a reduction in uncertainty and containment measures would not necessarily lead to a broad-based strengthening of consumption.

OECD Economic Outlook

The worst case scenario

Adam Tooze muses on how ECB’s worst case scenario, as presented in its most recent Financial Stability Review, could unfold:

We may have reached a turning point. But what if we have not? Imagine an alternative scenario. What if we are not in 2012 but in 2009? What if the relief we are experiencing is like the interlude of calm between the banking crisis of 2008 and the eurozone crisis that followed (as Erik Jones has helpfully framed it)?
Imagine if the pain is only just beginning.
In 2020 Europe’s economy has been on life support. Millions of jobs have been sustained by short-time working schemes. Guarantees of credit have been issued to staggering amounts. What if the support is ended prematurely?
Unemployment surges. The economy continues to contract into 2021. Credit falls off a cliff. As recession takes hold, loans turn bad and losses cascade through the financial system.
Europe’s banks, already in a weak position before the coronavirus shock, are caught napping. Their loss provisions in 2020 having been far lower than those made by their American counterparts, in 2021 they suffer a bloodbath. As their loan books deteriorate, weaker banks—above all in Italy—are downgraded to junk status, tightening their access to bond markets, further restricting their ability to lend.

Light in the tunnel or oncoming train?
By: Adam Tooze – Columbia University

Remarks on the US

In the US the picture is consistent with growth at a greatly decelerated rate. Some high frequency indicators suggest a negative growth rate for the end of November. Below is the Weekly Economic Index (Lewis-Mertens-Stock), released on December 1st, applying to the week ending 11/28.

Business Cycle Indicators as of December 1st
By: Menzie Chinn – University of Wisconsin