What’s different this time, and how might that shape the global economy once the pandemic has passed?
Similarities?
Historically, periods of falling consumer spending or recessions have been preceded by a combination of factors: restrictive monetary policy, balance-sheet weaknesses, or rising risk aversion that prompted households to save more. The origins and drivers of the current global shock are somewhat unique. Nevertheless, it’s likely of a similar size at least to the 2008 global financial crisis (GFC), so it’s still useful to compare the drivers and vulnerabilities in place at the onset of each of these episodes.
As a rule of thumb, deep recessions usually force any large unbalances to unwind. (These imbalances might be, for instance, an overheated property market or excessive levels of household or corporate debt). In turn, this constrains the speed of any recovery once the initial shock has passed. In this regard, there are several clear differences between the two pre-crisis periods.
Households are less indebted
Across the world as a whole, household debt is generally lower than it was in 2007, including the US and the eurozone – the two most systemically important economies. By contrast, the largest increase in debt has been in smaller developed market economies like Australia, Canada, Nordic countries and Switzerland. These regions suffered less during the GFC and then took advantage of the cheap and plentiful global supply of money in the years that followed.
Within the eurozone, France now stands out as one of the more vulnerable economies – household debt there has ballooned while in many other countries, it has fallen or stabilised since the GFC.
Bank lending drying up
It is interesting to note that lending conditions (as measured by loan officer surveys) had started to deteriorate across a number of countries in 2007. In the case of Spain, where imbalances related to the housing bubble were particularly stretched in 2007, both the supply and demand for loans had deteriorated sharply. Indeed, the Spanish economy had started to move into recession ahead of other developed market economies, with income and employment measures already contracting ahead of the global cycle. Spain then suffered a deep, protracted, double-dip recession.
Household debt in Spain has improved dramatically since the GFC and there were no major imbalances evident at the time of the COVID-19 outbreak. Now, as one of the epicentres of the pandemic, Spain will experience a deep recession as a result. The hope is that the healthier state of household finances will allow a stronger recovery from this current crisis.
For most countries, lending conditions were neutral during the first quarter of 2020. However, over the coming month they are expected to deteriorate, as banks react to the plunge in activity and loan demand dries up. This is despite regulation aimed at encouraging banks to be more supportive of businesses and individuals.
It’s worth noting that these surveys of loan conditions have in the past acted as a leading indicator for household spending. Therefore, they are worth monitoring during the eventual recovery phase.
Wealth – strength or weakness?
Just as we categorise excess debt as bad for consumption, we tend to treat wealth as a positive driver of consumption. However, as we learned during the GFC, when there is an overvaluation of assets (and therefore an overestimation of wealth), this positive driver can quickly become a vulnerability.
Indeed, households’ wealth position was generally better leading up to the coronavirus crisis than it was before the GFC. This is evident both in terms of the growth rate of wealth and the ratio of wealth to economic output.
The recent precipitous drop in asset prices will fundamentally change that picture over the coming months, particularly in countries like the US and UK where equity exposure is especially high.
Tougher times ahead for labour markets
Despite historically low unemployment rates across developed economies, employment and wage growth were already more subdued in the first quarter of 2020 than it was in 2007. Although it’s still early days, recent evidence points to surging unemployment in those economies where it’s easiest to shed labour (generally the English-speaking countries). However, the duration of the virus shock and its more persistent impacts will determine how much of that increase in unemployment will be reversed, and how quickly. Even if a rapid dismantling of containment measures is possible, labour market repair can take some time. Many of those who regain employment may not do so at the wage they earned before the crisis.
In many European countries – including Germany – short work schemes make it easier for firms to absorb short-term shocks to activity without the need to fire or fully furlough workers. However, these are harder to sustain over longer periods of time. Unemployment may also rise as vacancy and hiring rates plunge. Hence, a swift return to the record-low unemployment levels of recent years seems unlikely.
Central banks have less firepower
Another striking difference between the two episodes is central bank monetary policy. Ahead of the GFC, real interest rates (“real” meaning after taking inflation into account) were at restrictive levels. Heading into the COVID-19 crisis, the stance of central banks was more neutral. But, even with the broader and larger package of unconventional monetary measures now being rolled out, central banks’ ability to cushion the COVID-19 shock will be heavily constrained. With global interest rates already at record low levels – negative in some countries – remaining firepower is scant.
Lifelines from governments
This all serves to underscore the importance of fiscal programmes that governments and authorities are putting in place. Seeking to soften the impact of containment measures, they are appropriately scaling up a variety of schemes. These range from cash injections, expanded unemployment benefits and wage subsidies to debt-servicing holidays for individuals and bridging finance for businesses. The aim is to tide over corporates and households for as long as the disruption to the labour market lasts, so they can readily resume activity once the lockdown is lifted.
Those countries that scale up such policies the most, and keep them in place for as long as required, are likely to emerge from the current crisis in the strongest relative shape – especially in those cases where the household sector was in a strong fundamental position before the crisis.
Sree Kochugovindan, senior research economist, Aberdeen Standard Investments
