Yes, the economic decline in 2020 was the worst decline since the Great Depression and certainly much worse than the financial crisis a little more than a decade ago. No wonder that many pundits expect the recovery to be long and slow.
After the financial crisis, growth was slow and unemployment remained high for many years. But dare I say that this time may be different? On the one hand, central banks and governments had the financial crisis as a dry run for this crisis and used the template of 2008/2009 to reduce the negative impact of the pandemic on the economy. Central banks did what they could (which was not much, to be honest) but more importantly, governments were quick to roll out aid packages that in most European countries and the United States amounted to 20% of GDP.
At this point, nobody knows whether this was too much or not enough, but I am pretty sure it helped us prevent another Great Depression. And while I tend to criticise central bankers and economists a lot, I think this time we have to thank them for learning the lessons from history and unleashing a set of policies that prevented a much worse outcome.
This is one reason, why I am confident that the economic recovery this time will be swifter than after the financial crisis. Another reason is that the pandemic wasn’t a financial crisis and hasn’t evolved into one. And that makes a big difference.
Natalia Fuentes and Isabella Moder from the European Central Bank have used past episodes of epidemics, financial crises, wars, and oil shocks to show that the nature of the shock makes a big difference to the shape of the recovery. Using data from 117 countries between 1970 and 2017, they show that the economy gets back on its feet after an epidemic relatively quickly, while financial crises have a much longer effect and depress economic growth for years.
Economic recovery after different kinds of shocks
Source: Fuentes and Moder (2021).
After an epidemic, the economy typically returns to pre-epidemic levels within two years. Now that may be encouraging but be aware that pre-epidemic levels still mean that in the next decade we will face the problem of low trend growth and what is often called “secular stagnation” just like we did in the last decade. The only good news is that the 2020 pandemic is unlikely to make things worse than they were before. And that is something to be grateful for, I guess.