The economic crisis due to the coronavirus would be a free fall

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The impact on the economy of COVID-19 has been faster and more severe than the 2008 global financial crisis and even the Great Depression. In these previous events, the stock market collapsed 50% or more, loans were frozen, there were massive bankruptcies, unemployment rates rose. But all this developed in 3 years. In the current crisis, macroeconomics and finance has materialized in 3 weeks.

Earlier this month, the US stock market fell in 15 days; a 20% drop, the fastest decline in history. In other words, each component of demand, consumption, purchasing capital, exports, has an unprecedented drop. With production falling sharply for one quarter and then rapidly recovering for the next, it should be clear that the new coronavirus crisis is something else entirely. The graph of the contraction that occurs now seems to have no V or U shape or an L shape; which is a sharp drop followed by stagnation. Rather it looks like an I; a vertical line drop representing financial markets and the real economy plummeting.

Neither during the Great Depression nor the Second World War did economic activity literally stop, as it has happened in China, the United States and Europe. The best case scenario would be a severe slowdown in terms of reduced cumulative global production but shorter life, allowing a return to positive growth for the fourth quarter of this year, where markets would begin to recover.

The best scenario involves several conditions. The economies of the affected countries would have to implement COVID-19 test, trace and treat measures, forced quarantines and a large-scale blockade like the one implemented by China. Considering that it could take 18 months for a vaccine to develop and be produced at scale, antivirals and other therapies will need to be massively implemented.

Those responsible for monetary policy, who have already done in less than a month what it took them 3 years after the 2008 global financial crisis, must take less conventional measures. This means zero or negative interest rates; advanced orientation, quantitative easing; and credit relaxation (the purchase of private assets) to back-up banks, non-banks, money market funds and even large corporations (commercial paper and corporate bond facilities).

Governments must deploy a massive fiscal stimulus, direct cash outlays to households. Given the size of the economic shock, fiscal deficits in advanced economies should increase from 2-3% of GDP to around 10% or more. Only central governments have balance sheets large and strong enough to prevent the collapse of the private sector.

But these deficit-financed interventions must be fully monetized. If financed through standard public debt, interest rates would rise sharply and the recovery would be stifled from its inception. The interventions long proposed by leftists in the modern school of monetary theory have become mainstream.

Unless the pandemic stops, economies and markets around the world will continue their free fall. But even if the pandemic is more or less contained, overall growth may not return by the end of 2020. After all, another virus season is likely to start with new mutations; Therapeutic interventions that many have may be less effective than expected. Then economies would contract again and markets would collapse again. Furthermore, the fiscal response could hit a wall if the monetization of massive deficits begins to produce high inflation, especially if a series of negative supply shocks related to the virus reduce potential growth. And many countries simply cannot undertake such loans in their own currency. Who will rescue governments, corporations, banks and households in emerging markets?

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