Economic Scenario 2: Recession

Economic Scenario 2: Recession

The second scenario that could possibly happen is an economic recession. A recession is characterized by a sustained economic decline, which manifests in two consecutive quarters of negative GDP (Gross Domestic Product) growth. Furthermore, the time line for a recession is usually between one and three years. An example of this is the last recession in 2007/ 2008. The high of the market was formed  in October 2007 and the lowest point of the decline was reached in March 2009. So the entire down move lasted for one and a half years. This falls exactly within the timeline we established earlier and if the corona virus was to start a recession we would expect a similar timeline.

There are a couple of aspects, that could prevent a quick recovery and aid the economy going into a recession. First of all, interest rates are already at, or very close to zero percent in the US and Europe. Because of this Central Banks have less options within the realm of monetary policy. They can’t lower interest rates as they did in 2007/ 2008. Before the start of the recent decline in the markets the FED, contrary to the ECB, had some room left to lower interest rates, but they immediately used this option at the beginning of the downturn. The only option left to central banks is the use of direct monetary stimulus. Among these options are the use of helicopter money as well as lending directly to companies in need. However, even the effect of these direct stimuli is highly controversial among economists, especially for high public debt ratios. Nickel and Tudyka find: “From a policy perspective, these results lend additional support to increased prudence at high public debt ratios because the effectiveness of fiscal stimuli to boost economic activity or resolve external imbalances may not be guaranteed.”* Ironically this paper was published by the ECB, the same institution that has been relying on the use of stimuli for years. 

Interest rates already being at zero and the possible ineffectiveness of stimuli in the context of high public debt ratios massively limit the effectiveness of the central banks. These are also factors favoring the scenario of a recession.

Another aspect to consider is the virus itself. If the corona virus was to appear in waves over a couple of years, as the spanish flu in 1918 did, it might be necessary to disrupt supply chains for much longer than we assume at the moment, thereby also sending the economy into recession. 

*https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1513.pdf

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