Deciphering the Economic Upheaval of the Covid-19 Crisis

[upbeat music] If you're worried about the economic toll of the coronavirus crisis, you're not alone. It's scary. There is no clear forecast, and each country's experience will be different. Here's what we do know. A steady flow of money, goods, services, and the people to make them flow is essential to a healthy economy, and that flow is severed right now by life-saving stay-at-home orders. Recession is inevitable, but what kind of recession it will be and what recovery might look like is still unclear. To help imagine what could happen, authors from Boston Consulting Group point out that recessions and their recoveries come in various shock shapes. These are determined by how hard a crisis hits the supply side of an economy. That's an economy's inputs, capital, like machinery, factories, software, labor or workers, plus productivity, or how we use labor and capital productively. The harder the supply side is hit, the more credit is interrupted, meaning less money is injected in the form of loans to businesses and individuals to fuel investment, and the more difficult it is for productivity to recover. From best to worst, we have V, U, and L recession shock shapes. The V shape is a one-time dip. If credit can continue to flow, productivity and labor are less affected. You can see that growth dips, but recovers to its pre-crisis level and rate. The U shape is much more costly. Credit flow is disrupted, and growth drops precipitously, never rebounding to its pre-crisis path. The rate of growth recovers, see how the slopes are the same, but a large gap between the old and new paths represents one-off damage to the economy's supply side. The L shape is the worst. Credit is severely disrupted, not once, but perpetually, and there is very little new investment. This economy never recovers its prior output path, and the rate of growth also declines. The crisis leaves permanent structural damage to the economy's supply side. These examples represent crises that started in the financial sector, disrupting credit flow and thus capital growth. We have some off-the-shelf policies for dealing with these. However, we are now in uncharted territory with a double risk of a financial system shock and an epic freeze of the real economy, the households, firms, and government that deliver real physical goods and services. Countries have no existing playbook for dealing with this double shock. Months of necessary social distancing raises the risk of both types of problems, which can feed off each other in dangerous ways. For example, a prolonged crisis can drive up real economy bankruptcies of everyday people and firms, making it harder for financial systems to manage. And a financial system crisis would starve the real economy of credit, which could cripple investment and ultimately growth. In this combined crisis, capital does not grow, pushing the economy towards a U shape. Not good. However, we can head off a U or L-shaped recovery and lessen the intensity of the crisis. How? Primarily, innovation. On the medical side, vaccines, treatments, and capacity innovations are needed to save lives and end the economic damage caused by social distancing. On the