The Covid-19 pandemic is a global shock , involving simultaneous disruptions to both supply and demand in an interconnected world economy. On the supply side, infections reduce labour supply and productivity, while lockdowns, business closures, and social distancing also cause supply disruptions. On the demand side, layoffs and the loss of income and worsened economic prospects reduce household consumption and firms’ investment. The extreme uncertainty about the path, duration, magnitude, and impact of the pandemic could pose a vicious cycle of dampening business and consumer confidence and tightening financial conditions, which could lead to job losses and investment. Key challenges for any comprehensive economic analysis of Covid-19 are how to identify this unprecedented shock, how to account for its non-linear effects, how to consider its cross-country spillovers, and how to quantify the uncertainty surrounding forecasts, given its unprecedented nature.
The impact of Covid-19 on economic activity and long-term interest rates
There are several channels through which excessive global volatility can affect economic growth. They include higher precautionary savings, lower or delayed investment owing to increased uncertainty and weaker demand prospects, and a higher cost of raising capital owing to higher funding costs in a volatile environment. Following the widespread outbreak of Covid-19, as in previous episodes of financial stress, global volatility spiked.
Having shown the importance of the global volatility threshold effects for subsequent output growth. The counterfactual analysis with this model suggests that the pandemic will likely knock three percentage points off real world GDP relative to the level of global economic activity that would have materialized in the absence of the shock (Figure 3).
The US and the UK are quite likely to experience deeper and longer-lasting effects, while China’s outcome has more than a 50% chance of being much better.
Pulled by China, the rest of “Emerging Asia” has a higher chance of performing better than the global average. Non-Asian emerging markets stand out for their vulnerability. They will likely suffer from a significant output collapse in the first and second quarter of 2020 and have a less than 20-30% percent chance of not experiencing an output loss by the end of 2021. Turkey, South Africa, and Saudi Arabia grouped together as “Other Emerging Markets will almost certainly see at least eight quarters of severely depressed economic activity. We also estimate that the pandemic will likely lower long-term interest rates in the advanced economies. This is because the crisis raises precautionary savings and dampens investment demand.
. These findings highlight the importance of a comprehensive and a coordinated cross-country policy response to the pandemic. This includes global efforts to ensure swift deployments of medical resources (including vaccines when available), policy interventions that can restore the normal functioning of financial markets, as well as other measures that can support firms and households. Finally, a risk management approach to policymaking would call for activism to buy insurance against the tail events that are depicted by the distribution of likely outcomes. These efforts would likely limit the amount of scarring.