Let’s start by saying that the economy normally finds itself in a state of expansion. With more and more people constantly trying to work out things more efficiently, we can expect firms and households reaping real profits and income. Now, what happens if economic growth grinds to a halt and becomes negative? The answer is: it depends. One quarter of negative output followed by a new expansion is obviously no reason to panic and is usually explained by a one-off factor. Unfortunately, however, we’re not always that lucky.
Most economists would agree that a recession resembles a decline in economic activity that lasts for at least two quarters in a row. Moreover, traditional macroeconomic indicators including employment, household income, industrial production and company profits are all negatively impacted. For example, economic activity in the eurozone declined for four consecutive quarters during the 2008-2009 Great Recession. GDP shrank by almost 5% from peak to trough and the unemployment rate increased from 7.3% to more than 10% in the spring of 2010. There may be several causes. It can be triggered by unsustainable imbalances, like a bubble in the housing market in combination with very toxic assets in the financial system, as was the case a bit more than a decade ago. But it can also be the result of monetary policy tightening in response to higher inflation.
A depression, on the other hand, is far more uncommon and longer lasting. The Great Depression of the 1930s is what immediately comes to mind. During the major contraction phase, between 1929 and 1933, economic activity in the United States fell nearly 30 percent and the unemployment rate jumped from 2% to as high as 25%. This all happened in the wake of the stock market crash of 1929. Contractionary and budgetary policy efforts were presented as sound and prudent at the time but only made the crisis worse. Deflation set in, with prices falling between 5 and 10% per year during the early 1930s. The economy expanded again following Roosevelt’s inauguration in 1933 but only for a brief period of time. In 1937, when the Fed and the Roosevelt administration both thought the Great Depression was over, premature policy tightening caused the economy to stumble again. In fact, the unemployment rate remained in double digit territory for the rest of the decade, until the huge war efforts in the 1940s shot unemployment down.
The great lockdown
So, what’s next? Are we up for an economic recession or depression? Actually, it’s important to realize is that this is not an ordinary recession or even a rare depression, at least not from the start. We are not dealing with a typical collapse in demand stemming from risks built up over time in the financial system itself. This is more like a self-induced coma. Indeed, parts of the economy and society are being switched off as people fear contact and governments have urged them to stay home in order to limit the spread of the coronavirus. In essence, we don’t want people to go out and spend. We want people to stay at home instead. This is about maintaining the economic system so that we will see a faster economic recovery once the virus is brought under control. This means that governments and policymakers are not merely stimulating the economy, as some observers continue to describe their actions. Above all, they are providing life support in order to try to limit the hardship for millions and millions of firms and households.
What’s in a name …
Of course, the economic impact is absolutely brutal. Major economies including the United States and the Eurozone are looking at an initial impact of between 20 and 40% of GDP even though nobody really knows for sure at this stage. Moreover, in the United States the unemployment rate will likely hit depression-like levels. True, economic growth is still expected to turn positive in the second half of the year as restrictions are gradually being lifted. In that respect, the recovery can begin fairly quickly.
At the same time, however, epidemiologists keep on warning that only a vaccine will provide a final solution. That could still be twelve to eighteen months away from this point. Full recovery may take years, implying that it doesn’t make much sense to talk about a ‘temporary hit’. The upshot is that this crisis doesn’t let itself be labelled easily. But then again, there’s nothing to stop economists from trying.
As the IMF noted in its most recent economic update: ‘This is not the Great Recession, this is not the Great Depression, this is the Great Lockdown’.