When we look at the data, ten million Americans have made jobless claims over the last two weeks. We’re now seeing equally staggering figures come out of many other countries as economies are simply shut down.
The speed that the human tragedy has unfolded, and the acuteness of the recession that we are certainly in right now is astonishing. The fact that we’re seeing discussions that make comparisons with the second world war or the great depression means we really are in the midst of a Black Swan moment.
Looking at the transatlantic economies, US and Europe, we forecast that the trough will be in the second quarter and the US will drop 9.5 per cent in GDP. In the euro area we expect GDP to contract 3.4% in Q1 and fall a much larger 11.4% in Q2. In both regions we expect the rise in Q3 will be assisted by the more persistent and structural elements in the fiscal stimulus announcements and the reabsorption of involuntary savings after the collapse in consumption in Q2.
But this outlook would be much worse were it not for timely and aggressive monetary and fiscal policy easing. Policymakers have learned important lessons from the failures of the Depression and from dealing with the GFC. The Fed and ECB were quick to pull out all the stops to inject liquidity and confidence into financial markets. The scale of fiscal easing on both sides of the Atlantic has already exceeded the early days of the GFC.
While policy will buffer the impact of virus shock on economies, there will be lasting ramifications. In our baseline scenario, the level of GDP in the transatlantic economy (US and EU) at the end of 2020 will be ~USD 2 trillion below what we were expecting pre-virus. This is despite the “whatever it takes, whatever is necessary” policy stance. At the end of 2021, the level will still be USD 1 trillion below the pre-virus expectation. But, risks may be shifting towards a more negative outcome.
Divergence is Europe’s Achilles Heel and we are concerned the virus shock will again highlight North-South differences, for example, how tourism may expose the South to greater losses. Public debt to GDP ratios could rise 20-25pp in the South. This is particularly concerning since the increase in debt due to the financial crisis soon afterwards led to the devastating sovereign debt crisis of 2011/2012. European solidarity is being questioned and threatens to turn a socio-economic crisis into a political crisis.
We estimate that the US fiscal deficit will balloon to at least $3tn in fiscal year 2020, nearly 15% of nominal GDP. For comparison, this deficit is more than double that during the global financial crisis in 2009. Debt-to-GDP is likely to rise to about 95% this year, up from 79% in 2019, and reaching a level not seen since the mid-1940s. This accelerates the timing of debt equaling output by a decade. US debt-to-GDP was already on a relentless climb and this fiscal response, while necessary, will clearly exacerbate this trajectory.
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