Policymakers must stay the course as recoveries flag - Capital Economics
The Chief Economist’s Note

Policymakers must stay the course as recoveries flag

Economies still need help amid signs they are struggling to regain pre-virus growth paths

Economic rebounds have, until now, been about as V-shaped as we might reasonably have hoped for. But data released over the past couple of weeks suggest that the pace of recovery in several countries is now starting to lose steam. 

This is particularly true in Europe. The rebound in industrial production across the region appears to be slowing, and output actually fell in Germany in August; the impressive recovery in retail sales across the continent is also starting to tail off; and monthly GDP data for the UK in August were weaker than expected, despite the fact that government-support schemes boosted output in the hospitality sector.  

But Europe has not been alone in reporting softer data in recent weeks. September’s employment report suggested that the recovery in the US labour market has entered a new, weaker, phase. Australia’s economy has been hit by a new outbreak of the virus. And the rebound in several economies in Asia, including India and the Philippines, has begun to slow. 

What should we make of this? With so many stories playing out across the world there is a danger of missing the wood for the trees. Most obviously, it was always likely that the pace of recovery would slow following the initial rebound in output as lockdowns were lifted. 

More fundamentally, the huge scale of the collapse in output at the start of the year has also obscured some important aspects of the recovery. When key indicators fall and then rebound at double-digit rates it becomes hard to keep track of what’s going on. Two important points tend to get lost in the fog of data. 

The first is that there has been a significant variation in the performance of economies throughout the pandemic. It’s difficult to be precise about this, not least because the scale and nature of the shock has made it difficult for national statistics offices to fully capture the impact on output.  But we estimate that GDP is around 10% below its pre-virus level in India, around 7.5% below its pre-virus level in the UK, about 5% below in Germany, and around 4% below in the US. Meanwhile, China is unique among major economies in having already returned to its pre-virus level of output. 

These differences stem from three things: the success governments have had in controlling the virus and, related to this, the need for restrictions on activity; the size and effectiveness of policy support; and the structure of different economies. 

In most economies, the current shortfall in GDP relative to pre-virus levels is at least a large as the total peak-to-trough fall in GDP experienced in the global financial crisis.

In the case of China, policymakers have both quashed the virus and implemented a programme of monetary and fiscal support that has been particularly effective at stimulating short-term growth. At the same time, China’s economy has benefited from the shift towards online spending by consumers in developed markets. These factors help to explain its comparative outperformance.

At the other end of the spectrum, the much worse performance of economies in Europe can be explained in part by the failure of governments there to get on top of the virus, coupled with the region’s relative reliance on the sorts of service industries that have been particularly affected by social distancing measures and restrictions on mobility. The same could, of course, be said of the US, but the overall impact on GDP in America has been mitigated by a front-loaded fiscal support programme and the fact that restrictions to contain the virus have been less widespread.

The second point to stress is that, notwithstanding these differences, recoveries are slowing at a point where every major economy (with the exception of China) is still a long way from pre-virus levels of output. Chart 1 helps to put the current shortfalls in output relative to pre-virus levels I noted earlier into context by showing them alongside the peak-to-trough falls in GDP experienced by different countries in previous recessions. Despite a significant rebound in economies from the lows seen earlier this year, the amount of output that has yet to be recouped is, by any normal measure, huge. In most economies, the current shortfall in GDP relative to pre-virus levels is at least a large as the total peak-to-trough fall in GDP experienced in the global financial crisis.

Chart 1: Change in Real GDP (%-pts)

Change in Real GDP (%-pts)

So most economies are still in a very large hole. One consequence is that, while the depth of recession and speed of recovery has differed across countries, there is still a widespread need for policy support across all economies. And with monetary policy operating at its limits, it will fall to fiscal policy to do the heavy lifting. The economic outlook will continue to be determined to a large extent by success in tackling the virus. But, as I have argued throughout this crisis, the challenges will be compounded if governments begin to withdraw policy support prematurely.