The COVID-19 crisis is a game-changer for relative international resilience


National strategies in the wake of the pandemic's economic shocks may determine who is best able to weather the crisis.

By: Lynge Gørtz Smestad, Chief Analyst, EKF

According to projections from authorities such as the World Bank, the COVID-19 crisis is set to cause the heaviest economic recession since World War II, with a global fall in GDP exceeding five percent. The underlying economic structures are certainly distinct from other crises in our era.

Since economic recessions tend to be closely linked to fluctuations in lending, the impacts of COVID-19 differ in that the heavy fall in GDP is due to a sharp decline in income, rather than the credit shock of the 2008/2009 Financial Crisis.

This only adds to the difficulty of restoring each economy. Because unlike post-2008/2009, the main focus now is not on restoring the credit system, but on filling the income gap faced by many businesses and employees during the crisis.

Less muscle in monetary policy

In the past, the main lever for stimulating the economy was lowering interest rates, but since the rates have been low since the Financial Crisis, reducing them further will have little effect. This is why the central banks have sought to stimulate the economy by printing money and buying up securities.

The effect of that strategy, however, is equally limited, as the new money primarily benefits the fortunate holders of those securities, rather than those made jobless by the pandemic.

Fiscal policy stimuli

This makes fiscal policy the most effective instrument to resort to. While the many state compensation packages are certainly designed to channel money to those most at risk, fiscal policy stimuli are fraught with uncertainties. Firstly, because fiscal policy is not institutionalised in the same way as monetary policy, meaning that its probable outcomes are more variable and less reliable.

Secondly, ministries of finance cannot resort to printing money, so stimulus packages have to be financed by issuing government bonds. Under the new order, the central banks start printing money as soon as the ministries of finance have issued these debt securities. That calls for close coordination of fiscal and monetary policies.

The disparities in outcomes are now all in evidence. The USA has been far worse afflicted by the pandemic than Europe, yet the USA's GDP is "only" expected to shrink by 4.6 percent in 2020 against 7.5 percent in the Eurozone, partly because the American stimulus packages were more substantial. In emerging markets, the disparities are also striking.

Brazil was one of the hardest hit countries, but managed to keep its economy up and running through proactive incentives. Conversely, countries like Mexico and Russia have scarcely implemented any stimuli at all. This is evident in Mexico especially, where the economy is expected to suffer a contraction of more than 10 percent.

Vulnerable states hit the wall first

It is crucial for countries to strike the right balance. This is because there are limits to the amount of banknotes the central banks can churn out without pressuring the exchange rate and causing uncontrollable inflation. Some countries will almost certainly be better able to strike that balance than others.

The underlying economic structures are certainly distinct from other crises in our era

However, there will be a big difference in when a given country hits the wall. Countries that are already struggling with high inflation and reliance on foreign capital will run out of options first. This applies to several of the EU's neighbouring markets such as Turkey, where economic recovery may be a more distant prospect. This could impact Danish exports to the affected countries. Happily though, there is a way to go before Europe hits the wall, meaning that Denmark will be able to support domestic demand through economic stimulus for a good while longer.

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