The coronavirus is dominating the news and sparking panic in markets. We believe the options for policymakers are clear—but will they implement them?
In little more than a week, the coronavirus has been transformed from a largely Asian affair into a clear and present danger for the whole of the global economy. Sadly, the disease is exacting a growing human toll, and its spread has sparked record gyrations in global equity markets, pushed bond yields to new lows and prompted the US Federal Reserve (the Fed) into its first emergency rate cut since the global financial crisis (GFC). So how much of a threat is the coronavirus to the global economy and what can policymakers do about it?
Gauging the Threat from Coronavirus
Much about the coronavirus remains uncertain so we should exercise greater than normal caution when trying to gauge its impact on the global economy. Not only do we have limited visibility on the path of the virus itself, but the list of comparable historical examples to use as a playbook is short.
What we do know is that the global economy remains fragile, overshadowed as it is by rising populism and increased geopolitical tension between China and the West. We also know that many parts of the developed world are approaching the limits of monetary-policy effectiveness, and that a combination of these factors makes the global economy unusually vulnerable to negative shocks like the coronavirus.
The Economic Implications of Containment Measures
Until a week or so ago, the main channels through which the coronavirus was expected to affect the global economy were the direct hit to Chinese growth and supply-chain disruption elsewhere. The former has certainly been impressive, with February’s purchasing managers’ indices falling even more precipitously than during the GFC. But with the Chinese authorities expected to respond with aggressive policy stimulus, the overall damage to the global economy from these two channels was expected to be manageable, requiring only a modest downgrade to growth expectations.
Now, with the virus advancing outside China, this relatively sanguine view of the world is rapidly being overtaken. The key risk is that governments’ measures to contain the virus in the large developed economies will catapult the world into a deep recession. It’s still too early to draw firm conclusions, of course, but there are ominous signs. In Europe, for example, the focus is starting to shift to delaying the spread of the virus rather than trying to prevent or contain it. Indeed, it seems only a matter of time before governments start to impose onerous restrictions on various forms of economic activity.
Such is the range of possible outcomes associated with the coronavirus, that it’s impossible to boil the impact down to a single point forecast. We recently lowered our global growth forecast from 2.4% to 2.1%. That’s below consensus, would make 2020 the weakest year since the GFC, and probably captures most of the risks associated with the first two coronavirus transmission channels (i.e., the direct hit to China growth and supply-chain disruption elsewhere).
But it’s likely to prove too optimistic if widespread outbreaks in Europe and the US are accompanied by draconian measures to defeat the virus. In that scenario, global growth is likely to dip, temporarily at least, into negative territory—and it could be worse if this exposes underlying fragilities associated with rapid debt accumulation.
What Can Policymakers Do? Monetary and Fiscal Options
It’s these concerns that triggered this week’s emergency rate cuts from the Fed and other central banks. But while rate cuts are normally good news for investors, we need to be realistic about what central banks can and cannot achieve in the current situation.
We can have high conviction in central banks’ ability to prevent economic disruption from morphing into a liquidity crisis (should that risk arise). That’s especially true given the lessons learned during the GFC—indeed, many of the crisis-fighting tools created during this period are still operational. In addition, central banks can try to prevent a supply shock like the coronavirus from turning into a demand shock by taking steps to boost confidence, ease financial conditions and prevent equity market weakness spreading to the real economy.
But we can have much less confidence in central banks’ ability to address or offset the economic disruption itself. That would be true at the best of times, but it’s doubly so today with monetary policy having reached the limits of its effectiveness in many parts of the developed world (i.e. Europe and Japan). Moreover, monetary policy is a blunt tool that will do little to address the cash-flow problems of businesses and households in stricken areas of the economy.
That’s where fiscal policy comes in. As governments start to place restrictions on economic activity, it’s vital that they are accompanied by measures to minimize the impact on households and businesses. The good news is that there are increasing signs that policymakers get this. But it’s important that words are followed by effective action. If not, monetary stimulus may prove futile, insufficient on its own to prevent a deeper downturn should the coronavirus crisis continue to escalate.