A GLOBAL RECESSION IS VIRTUALLY CERTAIN

The combination of a coronavirus-induced growth slowdown and worldwide financial panic means that a global recession this year is virtually certain. After a few big bankruptcies and sovereign defaults, the world is likely to face a liquidity freeze. A liquidity freeze typically hits periphery countries that have their own currencies, which will collapse – prompting a flight to the dollar and the euro.

The sudden economic disruption caused by the new coronavirus is especially destructive because it is denting and in many cases destroying both supply and demand. Such a shock is highly unusual in advanced economies. Consider the effect on the airline industry, which is a leading indicator for many other sectors rather than an exception. Government directives to close borders have dealt another blow to demand. In response, airlines are sharply curtailing flights as they try to maintain operational and financial viability. The resulting staff layoffs and cuts to payments to suppliers will cause additional income losses that further depress demand in what economists call a “negative multiplier effect.”

The initial phase of the health response, while critical for saving lives, is only going to make things worse for the economy. Measures such as “social distancing,” separation, and isolation are inherently inconsistent with what drives economic growth, employment, and financial stability. Modern economies and governments are built for interconnectivity and integration. The health response will shut down one economic sector after the other. The result will be not just deglobalization and deregionalization but also massive economic shutdowns at the national and local levels.

For the private sector, corporate income statements and balance sheets will be hit hard, from all sides and with a force that will outmatch contingency plans for even the most extreme negative shocks. Revenues will decline sharply. Costs will go up. Cash cushions will be deployed. Credit lines will be drawn. New bond issuances will be almost impossible, especially for companies with significant debt to refinance. Stock markets will see huge volatility around a downward trend.

In such a scenario, investors and traders will scramble to reprice both equity (how much they are willing to pay now for a stream of future corporate income) and credit risk (how seriously they take the risk of default). The resulting shock to stocks and other risky financial assets will be amplified by structural fragility: lulled into complacency by ample and predictable injections of central bank liquidity, many investors have for years stretched too far and too wide in search of returns, and the system has accommodated their excessive risk-taking. Like a mass of people rushing to exit a small door, investors racing back to safety puts enormous pressure on the functioning of markets. And with that pressure comes heightened risk of financial instability worsening the downturn in the real economy—what economists call “reverse contamination.”

It won’t be easy to restart a modern interconnected global economy after the initial health threat has passed. Recovery will begin when health officials can assure people that the new coronavirus has been contained and that immunity to the disease it causes, known as COVID-19, has increased. (An effective vaccine would do both.) Recovery may not be instantaneous. Restoring normal staffing levels, inventory, and supply chains will take companies time after weeks or even months of inactivity. So will implementing and harmonizing government policies designed to get the global economy humming again.

Only the right response from governments, businesses, and individuals can limit the coming downturn, shorten its duration, and contribute to a sharper, stronger, and more sustainable recovery. The first phase of the response should involve targeted and timely government interventions to protect the most vulnerable segments of society, to safeguard critical sectors of the economy (starting with health care, where rapid progress is the key to establishing an economic bottom), and to ensure that financial markets continue to function soundly. To the extent that is possible, governments should refrain from relying on general policy tools such as interest-rate cuts and broad fiscal stimulus during this initial phase of the response. The political pressure to make use of these tools will be overwhelming—and indeed, the U.S. Federal Reserve has already cut rates sharply to near zero—but their effectiveness in a moment like this is much diminished. After all, are people who are panicking about a pandemic likely to start traveling or taking cruises again if they are given tax credits or cheap loans?

Only as the new virus is being contained and immunity enhanced should these general policy tools be deployed en masse as part of the second phase of recovery. Ideally, this phase will also target sectors and activities that improve longer-term productivity and growth, such as infrastructure and education. There will inevitably be tough decisions to make about whom to bail out, why, and how.

Governments should also coordinate, both internally, to enable “whole of government” responses, and externally at the regional and global levels. Government and central bank policy interventions can be turbocharged by well-designed and well-executed public-private partnerships. And the impact of these partnerships, particularly on financial markets, can be amplified and accelerated by clear, transparent, and consistent communication.

While governments move to stabilize economies and financial markets, banks and private companies can help minimize the severity and duration of the coming recession by doing their best to prevent liquidity problems from becoming solvency ones. Bank forbearance would be of great help, as would special funding windows for small- and medium-scale enterprises.

The new coronavirus shock is also likely to alter the global economic terrain, resulting in a “new, new normal.” Deglobalization and deregionalization will accelerate, redefining worldwide chains of production and consumption. Public- and private-sector emphasis on cost-effective and efficient global supply lines will give way to excessive risk aversion and resilience management. And economic tools, particularly related to trade and investment, will be weaponized more frequently as national security trumps economic concerns. The global economic landscape will look different when the dust settles from the new coronavirus shock. But with timely collective action, the pain of the coming recession can be limited.