The economics of lockdowns

  • “Lockdowns” are becoming the norm when dealing with covid-19. They will trigger steep – if hopefully transitory – contractions in GDP.
  • Business cash reserves are scarce in the US, but everywhere credit will need to flow to avoid second-round effects
  • Fiscal deficits will probably be quite high this year. Levels close to 5% in Europe are not unreasonable, and significantly higher in the US.
  • We contrast the forcefulness of the Fed’s decision on Sunday with the ECB’s constraints. We think political decisions around the ESM could unleash the ECB’s firepower. More action could still come from the Fed though, but the fiscal response is still lagging.

More lockdowns ahead

We think it is reasonable to assume that “lockdowns”, following the Italian, and then French and Spanish examples, will become widespread in the Western hemisphere. This will trigger very steep declines in GDP, hopefully transitorily, as output is some sectors will fall to nearly zero. We need to stress-test businesses, banks and governments for such significant shocks. Our conclusion is that readiness – not necessarily the actual implementation – to engage in large-scale quantitative easing would be necessary to nip in the bud second-round effects on business survival and the labour market, paving the way for a brisk rebound once the epidemic is under control. The Fed has made swift progress on this this weekend. The ECB made the most of its constrained framework once again. But we still need to see the materiality of the fiscal push which this new phase of monetary accommodation has just been made more financially sustainable.

When it comes to handling the epidemic, all countries want to be like South Korea, with Hubei as the adverse scenario. Unfortunately, for now the propagation of the virus in Italy – the most advanced European country in the epidemic – follows very closely the profile observed in Hubei with a lag of 37 days (see Exhibit 1). The Italian government is resorting to increasingly draconian measures – and there are some tentatively reassuring signs the number of new cases is abating in the first “red areas” in the North - but given the average incubation time (5-6 days) we will have to wait until early next week to see if the latest wave of containment measures has been efficient.

We probably need to take Italy as the right benchmark for the outlook in the other European countries. As we suggest in Exhibit 2, the epidemic is advancing in France, Spain and Germany with a lag of about 8 days behind Italy. France and Spain have now resorted to draconian “lockdown” measures themselves, and we think it is (or at least should be) what we will see in the rest of Europe very soon…and possibly a bit later in the US.

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