The bigger lessons of the coronavirus shock

The spread of coronavirus is now the top item on the international macroeconomic agenda. The Federal Reserve was “closely monitoring the emergence of the coronavirus”, its chair Jay Powell told the US Congress this week. Analysts expect the disease to have a significant impact on growth — one estimate has cut 0.5 percentage points from the global rate of year-on-year growth this quarter. That is almost half a trillion US dollars’ worth of lost economic activity. The reason is the disruption caused to the Chinese economy combined with the role China now plays in global value chains, as my colleague Valentina Romei has charted.

That a phenomenon that hardly existed a month ago should have such potential impact should give us pause in terms of how well we think we understand the economy. So here are three observations from the coronavirus crisis to consider — and tentative lessons to draw.

First, note how the car industry is at the centre of the possible contagion — economic, that is, not epidemiological — because of Chinese shutdowns causing slowdowns elsewhere. Of course, other industries are at risk as well. But the auto industry is important for two reasons: carmakers have warned about the impact almost immediately (car plants in Europe and South Korea are already being forced to halt production because they lack Chinese-made parts), and auto manufacturing remains a core sector in the biggest industrial economies. The iconic position of car production is not unfounded: it serves to highlight just how globalised production patterns have become and, as a consequence, how interdependent countries’ economic fortunes are.

Second, the car industry is facing the virus-induced supply shock after already suffering a series of blows. “Dieselgate”, the uncertain future of the internal combustion engine and the rise of electric vehicles, the trade barriers of Brexit (see “Other readables” below), and the trade wars waged from the White House — all these have contributed to the industrial recession in Europe and America, and coronavirus can only make things worse. This raises a broader question: how do we distinguish between one-off disturbances and a downward trend? For 18 months, policymakers have been talking to me about having to establish whether industrial weakness is a blip they should ignore in setting policy, or a sign of more protracted weakness that calls for a policy change.

The sequence of bad news for the car sector should perhaps make us reconsider that distinction. After a while, what difference does it make whether a slowdown or recession consists of one long contraction or many small ones? If causes are hard to establish, policymakers may want to focus on more observable factors, such as whether the weakness has lasted for some time (in which case, enact more stimulative policy), or whether the initial shock looks like it is setting off self-reinforcing dynamics (in which case, definitely enact stimulative policy). Such dynamics could include spillovers into related but initially unaffected sectors, or consumers responding to supply disruptions by holding back demand.

That last possibility leads to a third, even more general point. Economic analysis usefully separates events into demand shocks (which change what people want to buy) and supply shocks (which change what people are able to sell). In practice, the coronavirus crisis shows that most economic events are both. While the epidemic clearly starts as a hit to supply in China — with people unable to move or go to work, and with international business connections hampered too — the income hit for Chinese workers and the reduced need for imported commodities and industrial inputs both translate into immediate negative demand shocks. The same, of course, then happens in the markets where the repercussions are felt. Falling demand, in turn, tends to make businesses hold back investments, reducing future supply capacity further from what it would otherwise have been.

The commingling of demand and supply shocks is, in a sense good, news. Policymakers have tools to deal with both — but the supply side is harder to improve, requires more targeted policies and takes longer to show results than demand-side policies. The fact that demand is almost always involved, in other words, means macroeconomic policymakers almost always have a task to fulfil, and if demand affects supply, they may even somewhat mitigate supply problems down the line.

So here are the general lessons the coronavirus episode can inspire. We are all interdependent, the economy can turn more suddenly than we think — and macroeconomic policymakers should act early and act often.

Other readables

• I have interviewed Thomas Piketty about his new book and wealth tax proposal.
• Despite the protests, I argue that French president Emmanuel Macron may see his pension reforms as an agenda going according to plan.
• Can Britain’s car plants stay open after Brexit? The FT investigates — and the answer appears to be that if they do, it will only be through a degree of UK automobile autarky, or “British cars for British drivers”. That in turn will mean less choice and higher prices.
  
• Gavyn Davies explains why the Federal Reserve’s central bankers may change their monetary policy approach to something like “average inflation targeting”.
• Klaus Regling, head of the European Stability Mechanism (the eurozone’s rescue fund for cash-strapped governments), has joined the chorus calling for a stronger international role for the euro, in a post on the ESM’s new blog. Ultimately this will require deeper liquidity, better risk-sharing and a common safe asset in the euro area, he writes.

Numbers news

Source: Economy - ft.com