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The "all-in" policy response to Covid-19

August 20, 2020

reading time: 5 minutes

by Calvin Ha, Investment Strategist, LGT

The reaction of governments to Covid-19 resembles a roulette game.

No matter what industry or country - the pandemic has left its mark on the economy of all countries. Governments are responding to this with various support measures. We provide an overview.

First and foremost, the spread of the coronavirus known as Covid-19 represents a humanitarian and public health crisis, having reached more than 200 countries since the World Health Organisation (WHO) declared it to be a pandemic in March 2020.  In its wake, the virus caused a “sudden stop” in economic activity given the lockdowns and containment measures imposed in many countries. 

Global trade has been seriously impacted as end demand plummeted and supply chains became disrupted, and employment around the world is still facing the greatest challenge in decades.  While this is perhaps most obvious in industries such as travel, leisure, entertainment etc., it can be argued that no service or industry has been left untouched by this pandemic.  

Covid-19: Many countries are in recession

Indeed, the below chart from the International Monetary Fund (IMF) records that 80 percent of countries are in recession, the highest reading since the data begins in 1871. As such, countries are taking unprecedented measures to contain the spread of the disease, through a combination of massive fiscal support and monetary easing, alongside public health measures.

Chart of countries in recession from 1900 to the Covid-19 crisis.

How the US supports economy

In the US, the authorities passed a 2.2 trillion US Dollar (about 11 percent of GDP) fiscal package  in March 2020 in response to the economic fallout. Another round of stimulus is in discussion now, as emergency federal unemployment benefits expired at the end of July.  

On monetary policy, primary easing measures include the lowering of the Federal Fund rate by 150 basis points to 0-0.25 basis points in March and the introduction of various lending facilities to support the flow of credit.  These measures are aimed, in our view, at limiting job losses and preventing companies, especially small and medium-sized enterprises, from going bankrupt during time of economic dislocation. 

The measures of the EU

In Europe, the European Council of Ministers agreed on the Next Generation EU (NGEU) recovery fund on July 21, which will provide 750 billion Euro in total, financed by borrowing at the EU level. The emergency fund is expected to distribute 390 billion Euro of grants and 360 billion Euro of low-interest loans, and in doing so, importantly complements the individual efforts of member states to combat the virus, in our view.  Beyond Europe and the United States, the combined Covid-19 related fiscal spending totals in the trillions of US Dollars.

Key question: is a sustainable economic recovery taking shape?

Indeed, looking at the performance of stock markets and other riskier assets thus far this year in isolation, a casual observer could be excused in thinking that the "worst is behind us". One possible explanation for the resilience of stocks in 2020 could be that financial markets are already discounting the development of a Covid-19 vaccine, which could 're-set' the world economy back to a pre-pandemic state. 

This view can be supported by evidence that in those areas where lock-downs and other containment measures are lifted, both consumers and businesses appear to release "pent up demand", and for example, retail sales tend to rebound very swiftly. On the other hand, ending containment measures has also been associated with "second waves" or flare-ups of Covid-19, risking that regional authorities are forced to bring back social distancing and so on, applying the break again to an economic rebound.

Our assessment on the containment measures

In our view, the trillions spent on economic support and monetary easing measures are necessary but not sufficient alone to end the current public health and economic crisis. In short, they appear to "buy time" for the global economy as effective vaccines are developed and tested, before they are widely available around the world. 

We are also of the view that globally central banks can and will sustain highly accommodative policies for as long as needed.  Fiscal mathematics are more challenging, however, and the current impasse in Washington DC over the size and timing of the next broad rescue package attests to this complexity.

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