Real and financial lenses to assess the economic consequences of COVID-19
Catherine L. Mann15% decline in the February exercise. Falling energy and commodity prices undermine
investment and GDP growth in exporting countries, but are potentially positive for
importers, business users, and consumers.
- Financial markets initially ‘looked through’ the corona virus shock.
After an initial selloff at the end of January, markets – even in China – rebounded, with
US markets reaching a new high. There could be several reasons for this. First, there
was limited data to evaluate the impact of the various shocks and little evidence of virus
transmission to other economies. Relatedly, the market may have believed that a quick
rebound in China would lift other economies and that, on balance, the near-term lower
energy prices would be positive for the global economy. The third reason is that markets
apparently assumed that monetary policy will react to cushion the global economy, as
has been the case in recent years.
But then the markets sold off dramatically. An apparent reassessment of the data
spillovers, the transmission of the virus, the shock to uncertainty and the hit to
sentiment precipitated a generalised market sell-off. Various research, including Citi’s
own Financial Conditions Index and the financial conditions indexes created for the US
Monetary Policy Forum 2020 research paper (Cecchetti et al. 2020), shows that the most
important factors underpinning changes in financial conditions are equity valuations
and volatility. An important question is how long the level of financial conditions will
remain as accommodative as it is now.
- The rise in uncertainty and its effect on sentiment and financial conditions
are key.
The COVID-19 outbreak has increased uncertainty and negatively affected sentiment
through (1) how authorities are responding (via mandate or recommendation); (2) how
consumers are responding to the fear of infection (and the authorities’ suasion) by
staying home, telecommuting, and so on; (3) how business sentiment is responding
to the virus, as well as to both weaker trade and domestic data. Historically, a rise in
uncertainty and a hit to sentiment have been associated with weaker real activity data
with a lag of two to four months. The financial markets have taken note.
For both uncertainty and financial conditions, the current levels matter for how changes
affect the global economy. Investigation using threshold VARs shows that a rise in
uncertainty (due in this case to the outbreak and transmission of the virus) has a greater
impact on economic activity in a environment of high uncertainty than when uncertainty
is low; the current environment was one of high uncertainty even before the coronavirus