By Dr. Michael King. Originally published in the summer 2020 issue of Business Class magazine.
We are living through a health crisis and a confidence crisis. We are also experiencing an economic crisis that has crippled businesses, destroyed jobs, and caused financial hardship for many Canadians.
The key word to describe the current situation is uncertainty. We are at the start of a global recession, but how long will it last? The optimistic case is that Canada’s economy will bounce back swiftly with a V-shaped recovery in 2021, but the more likely scenario is a protracted U-shaped recovery. We may also experience multiple waves of infections and economic shutdowns, or a W-shaped recovery. The recovery hangs on the widespread availability of a vaccine, better treatments and broad testing to provide reliable data to guide decision-making.
I break down the economic impact of the COVID-19 crisis into three phases:
PHASE I: Stop the Panic in Financial Markets
As the pandemic spread to North America and the World Health Organization declared a global pandemic on March 11, we saw a jarring drop in stock markets. The Toronto Stock Exchange (TSX) Composite Index, which peaked on February 20 following an 11-year bull market, fell by as much as 43% by March 23. The sell-off began on March 12 with a drop of 12%—a post-war record—followed by a 10% rise the next day, followed by another 10% drop. This volatility has not been seen before. Both the price of oil and the exchange rate for the Canadian dollar versus the US dollar fell sharply. The main US stock market index—the Standard & Poor’s (S&P) 500 Index—also fell by as much as 38%. To provide some historical perspective, the S&P 500 Index fell by more than 50% during the Global Financial Crisis from late 2007 until early 2009, then took 49 months to recover that loss.
As public confidence collapsed, the Bank of Canada (BoC) and Government of Canada took dramatic actions to support the financial markets and the real economy. The BoC cut its overnight policy rate by 150 basis points to 0.25%, and intervened in fixed-income markets to restore liquidity and to provide emergency funding. Canada’s government announced fiscal support of $200 billion through the Canada Emergency Response Benefit (CERB), the Canadian Emergency Wage Subsidy (CEWS) and many more fiscal stimulus programs. These actions supported confidence and put a floor under the stock market and the economy, halting the panic.
PHASE II: Ending the Global Lockdown
Based on the simulations from epidemiologists, up to 25% of the population was forecast to contract COVID-19 within several months, overwhelming hospitals and leading to thousands of needless deaths unless strong health measures were taken. Heeding this advice, Canada’s lockdown began mid-March with advisories to shelter at home, practice physical distancing, avoid non-essential travel and quarantine for two weeks when returning from abroad. Under this original “strong intervention” scenario, the curve of infections would be flattened, peaking in mid-summer and then falling by year-end 2020. Much of the economy would be shuttered or severely reduced as we sought to save lives. Similar actions around the world led the IMF to call this phase the “Global Lockdown.”
We are currently navigating this phase. How long it lasts and the repercussions for the economy depend on the rate of new infections. Fortunately, infections have been falling in Canada and abroad, allowing a number of countries and some Canadian provinces to open up slowly. Now we are waiting nervously to see if there will be a second wave of infections, in which case the lockdown may be re-imposed. Only time will tell. But we will likely have to open up and shut down multiple times in the coming months.
PHASE III: Recession and Recovery
Phase III is a recession (which is certain) and a recovery (which is uncertain). The IMF has provided two sets of forecasts. Advanced economies are expected to drop by -6.1% over 2020, followed by a recovery of +4.5% in 2021. The comparable forecasts for emerging markets are -1.0% and +6.6%, respectively. The range of uncertainty is huge in any chart you might see on this subject. Confidence is a big part of this. If people believe things are getting better, their behaviour could make it a self-fulfilling prophecy.
What Are the Sources of Uncertainty?
Vaccines, containment, consumer and business spending, behavioural changes, consumer demand for things like restaurants and travel, bankruptcies and unemployment—all these things could affect the shape of the recovery.
What is certain is that government debt levels will increase, creating a drag on the economy for years to come. Canadian federal debt levels are around 50% (with provincial debt pushing it to 100%). Past frugality and balanced budgets gave us the room to support our economy now. The US federal debt is set to surpass 100% of GDP—a level not seen since World War II. The only way to pay down this debt is higher taxes and/or lower spending. So prepare for future belt-tightening.
This is a brief sketch of what the current economic outlook is, and how we got here. I welcome readers’ questions on this topic at michaelking@uvic.ca.
Dr. Michael King is associate professor and Lansdowne Chair of finance at the Gustavson School of Business.
For more from Michael on this subject, see the webinar he presented in spring 2020 as part of Gustavson’s Uncharted Waters series:
Photo credit: UVic Photo Services
