The “U” and the Nike swoosh: two scenarios for economic recovery
There is a consensus that the second quarter’s economic figures will be historic, with a contraction in activity unknown in peacetime in recent centuries. There are already diverse opinions on what is going to happen after the summer, and next year. Some are betting on a relatively rapid recovery in activity, which will allow us to recover everything lost over these months next year. Other, more optimistic opinions predict prolonged effects from the crisis up to 2023.
Thus, MAPFRE Economics‘ latest 2020 Economic and industry outlook report incorporates two alternative scenarios in its macroeconomic forecasts. “The question is whether the global economy has indeed bottomed out in the second quarter and whether now, thanks to the implementation of fiscal and monetary policy measures, we are entering a gradual phase of normalization that will bring growth back to positive territory by the beginning of next year. Or if, on the contrary, biological uncertainty regarding a challenging widespread immunization effort with increasing outbreaks, coupled with insufficient economic policy measures being implemented, leads to a prolonged crisis with more extensive effects and financial side effects that underpin a recession not only in 2020 but also 2021.”
In this first view, the economy recovers gradually as the restrictions put in place by countries due to the pandemic are gradually lifted. Under these circumstances, the world economy would contract by 4.9 percent in 2020 (two points higher than expected in March), but in 2021, the world’s aggregate GDP would remain above where it was in January this year, after growing by 5.4 percent. The result is a deeper, longer-lasting, but temporary U-shaped recovery.
According to experts from MAPFRE Economics, in this scenario, “COVID-19 will leave scars on the economy and undermine its recovery later, but will not eliminate it. This outline offers potential as long as employment and expectations continue to maintain prospects for improvement, something for which national and regional aid plans are crucial.”
In this alternative scenario, a second wave of coronavirus infections would cause a return to global lockdown. Domestic demand would stagger as new restrictions are introduced, to end up falling even below the levels of activity experienced in the first wave. Financial damage would weaken the balance sheets of households and businesses by preventing consumption from recovering.
In this case, global unemployment would increase especially due to structural factors, and recovering previous employment levels would become much more tortuous. Thus, potential GDP does not recover its original path until after 2023. The drop in GDP this year would not be much more pronounced than in the baseline scenario (-5.7 percent), but the contraction would continue in 2021 with a further decline of 2.2 percent worldwide.
The manifestation of this more gloomy scenario would entail certain consequences that MAPFRE Economics highlights in its report:
- A return to more severe lockdown and social distancing would lead to an immediate contraction of household consumption and business activity to levels below those observed in the first wave of the pandemic.
- Global trade would fall sharply again with effects on demand, but also on the incomes of countries producing raw materials. The Brent price could return to below USD 25/bl, putting emerging oil-exporting countries in a difficult position.
- Global financial conditions would again be impaired, to the extent that the USD strongly appreciates. Portfolio and credit flows to emerging markets could again vanish, causing sequential bankruptcies and balance-of-payment problems to begin to spread to more significant emerging countries, particularly in Latin American and European emerging markets.
- Equity would again show a change in long-term expectations (including real estate investment), and strong price/earnings ratio corrections would trigger adjustments to balance sheets in the corporate real estate and finance sectors. The value of global equities would return to mid-March 2020 levels.
- Risk aversion would reappear, causing new disposals of portfolio flows from emerging markets. This high and persistent level of risk aversion would contribute to a slow recovery.
- Fiscal support would be more limited and less effective than in the first wave. After an initial costly wave, the political response would be more skewed toward monetary measures, with the Federal Reserve pushing interest rates to the effective lower limit until the end of 2024, and the European Central Bank halting any expectation of developing an eventual and timid agenda of monetary normalization.