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How will this recession differ from the last two?

by Elizabeth1 min read31st Mar 202022 comments



My model is that the last recession (2008) was essentially financial in nature- a bunch of wealth was destroyed on paper but we lost no productive capacity. The 2002 recession was similar- most of what happened was revealing that things were valueless, rather than destroying value.

I expect this recession to be different, because it stems from an actual decrease in the availability of labor (although it's still subject to demand spirals stemming from that). I'd expect it to have more in common with the 1972 oil embargo (on which I can find zero books), which was also a sudden decrease in the supply of a crucial production component. How will the supply shock nature change the consequences of the recession? Or am I wrong that this one will be different at all?

Note: These questions are intended to provoke more babble than prune. But even the babbliest thing should be presented such that other people can build on it. So if you have a prediction, please share the reasoning or data behind it as well.

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Economics Explained argues that I'm wrong, and this recession was caused by high leverage on mediocre bets, just like the last two.

Technically the current recession won't be an official recession until the end of Q2, after two months of GDP decline. But this won't be a recession like any other we've seen in the 21st or 20th Centuries, so let's not quibble over definitions.

We've never before seen 10 million jobs lost in two weeks. And still haven't. The actual number is likely far higher, but most unemployment is run by the States, and many States have antiquated systems that couldn't handle the application load. Here in April it's months too soon to see how fast tens of millions of jobs can be lost, and how far down unemployment ends up.

In terms of history, the official unemployment rate at the height (depth?) of the Great Depression was 25%. We could very well be there by June, less than four months from the first pandemic lockdowns. At best, it'll take years to re-hire that many employees.

Add to that a highly likely repeat of the Panic of 2007-2008. The $2 trillion CARES Act allows for a three month moratorium on all mortgages backed by FannieMae and FreddyMac. Almost 70% of all mortgages. 90 days without payment puts every RMBS at risk of default, and failed RMBSs were the root cause of the last economic crisis. Is there another AIG betting long in the RMBS market? Are there more Lehman Brothers at risk? We don't know as nothing was actually done to fix the stability of the financial markets after the last financial crisis. We're just as much in the dark here in 2020 as Bernanke and Paulson were in 2007. (https://www.cnbc.com/video/2020/04/06/mortgage-industry-on-the-brink-of-collapse-coronavirus-economy.html)

What we do know is that the Federal Reserve does work as a backstop to the money markets and financial markets. At least we know it worked the first time. But we didn't have a chance to unwind the $3.2 trillion of extra money the Fed printed to solve the last crisis. The Fed was authorized in March to print another $4 trillion to keep the markets working in 2020. Given at least half of the GDP currently on pause, that is probably not going to be enough. We don't know what happens if the Fed's balance sheet reaches 50% of GDP. All we know is that when Germany tried the equivalent back in 1920's, it didn't go well for the Papiermark. For that matter, the Franc and Pound might have both defaulted if not for the U.S. backing the Entente powers after WWI. (https://lunarmobiscuit.com/lords-of-finance/).

Lastly, no previous recession or depression included the risk of death. Yes, the Great Depression ended with the industrial production of WWII and troops being sent off to fight a war, but the masses of citizens on the home front were safe from the daily fear of death. Not so this time. Until there is a 100% cure or proven vaccine, the economy can't simply switch back on. No doubt some Governors will lift the lockdowns as soon as the numbers look small, but until a cure or vaccine (or a massive plan for weekly testing), we will be 45 days from 100 community cases to overflowing hospitals. We have a long way to go before we can start rebuilding the economy, and that recovery will be a lot longer and more arduous than the Great Recession or the Great Depression. Let's hope it doesn't speed up due to World War III.

I think perhaps the best way to contrast the prior recession and the one we will be entering is the difference between the old credit cycle (ABC) theory and real economic shock recessions, as you seem to be doing.

I'm not as convinced the real shock will be the hit to the labor markets or even really a lack of aggregate demand. I suspect the way it will pay out will be closer to the post WWI and then great depression era type shocks. These were huge shocks to the global economic order and supply chain structure of that time. The pandemic is having a similar impact to global economic trade and relations, at a time were pressure on the existing structure was already starting to show where the cracks and fragile points lay.

While clearly Say's Law does apply, and those that lose the market to sell into may lose their ability to express demand for other peoples output -- and that will then cascade. But I would expect the response to that would be reallocation of domestic resources into increasing supplies for those lost imports. Additionally there will likely be more politically and geographically aligned trading blocks. Perhaps the implication there might be some shifting in the margins for where countries or regions are able to define their comparative advantage in trade.

Rebuilding the economic nexus (from any one countries perspective) will take some time. One might also expect that aspects of both economies of scale and perhaps scope will require the notch down in overall productivity/value creation in production due to higher average costs. But over time that will spawn new technology and so may be a wash. (I've been one of those who has not been fully on board with the whole globalization theme as a good plan. It is the easy path forward but is more fragile. A less integrated world economic structure will be more robust in the face of a greater set of shocks. I also think people will find ways to be as efficient as we have been up to now so overall wealth for the world will be close to the same.)

Prediction: Births will decline precipitously (BOTEC: 20%-60%).

A normal recession sees a drop in birth rates of ~9%, although that is typically made up mostly of delays rather than entirely foregone children. Due to fear around interaction with the medical system, I expect it to drop much more than that.

BOTEC: ~40% of births in the US result from unplanned pregnancies. If no one took any additional precautions due to covid and everyone who was planning a pregnancy chose to postpone, that would decrease births by 60%. In reality I expect some "unplanned" pregnancies to be planned out of existence as people take more precautions, and some people to plan pregnancies even given the circumstances (disproportionately older women whose fertility window is running out, although births using fertility treatments will decline), but 60% is still a good upper bound.

I expect at least as many people to prevent pregnancy due to covid as prevent pregnancy during a recession, so there should be a minimum of 2x as many foregone or delayed births. With rounding, that's a 20% floor.

There were important obstacles to wealth creation in 2008. Inflation went negative for a while, which meant there was a decline in the wages at which labor supply and demand would remain stable. Yet wages don't adjust downward in dollar terms - employers lay off workers, rather than cut wages, because wage cuts create very unhappy workers. That's a substantial fraction of what went wrong. [This is a very condensed summary of Scott Sumner's book The Midas Paradox].

That's also happening today. Prices have declined, or at least wholesale commodities have. Wages likely haven't declined to compensate.

Yet for this month, that's just a tiny part of what's happening. Wage adjustments wouldn't keep waiters or oil drillers employed. I expect there's currently a severe shortage of nurses and delivery people, which won't be quickly solved. In that sense, what we're experiencing is a massive shift in labor, more comparable to what happens in a major war than to what happens in a recession.

Value was destroyed by WW11, the 1957 pandemic, the 1968 pandemic, and 9/11. Yet it's unclear how many of those caused recessions.

Wars and severe pandemics tend to cause inflation (for pandemics, that's likely only significant if people doubt that they'll live long enough to value having money a year from now), and inflation tends to postpone or prevent recessions.

Whether we get 2008-style labor market imbalances depends a fair amount on what inflation is like over the next couple of years.

The TIPS spread implies that the market expects low inflation for a long time, which tends to suggest a long, drawn out recession.

But I have low confidence in any forecast along these lines. Will large fractions of the newly unemployed prefer unemployment checks over new jobs that are, for now, relatively high stress and high risk? We don't have much historical evidence to guide predictions here.

The Fed has substantial power to influence inflation, but seems to have a strong tendency to under-react to large changes.

The ISM Purchasing Managers report is the fastest way to get a decent estimate of how GDP is increasing or decreasing. The ISM report on March activity surprised many people, including me, by reporting a nearly neutral level of 49.1 for March. That's a big difference from the 38.9 that was reported on October 1, 2008, which was the biggest single piece of evidence that convinced me to sell stocks in advance of the worst part of that crash (I did not handle this year's crash anywhere near as well as that). Readings below 40 indicate sharp contractions, while readings near 50 suggest activity is nearly unchanged.

I'm changing my estimate of Q1 GDP to approximately unchanged, and I'm confused as to why the ISM report doesn't show recession-like changes.

"a bunch of wealth was lost on paper..."

I think you make light of the fact that 861,664 families lost their homes to foreclosure in 2008

No direct prediction from my side but a link to a report: https://www.mckinsey.com/business-functions/risk/our-insights/covid-19-implications-for-business

The full PDF report (linked on the website) has on page 15 a overview of possible outcomes that could be a basis for discussion.

The last recession didn't have a major impact on society. The job market was tough for a few years, but the inevitable progress of technology sent the stock market to all time highs while things continued on as before.

This recession calls into question many of the basic tenets of capitalism. What does it say about the basis of the monetary system if rent and mortgages could be suspended for 6 months with essentially no consequences? The society that comes out of this in a few years may look quite different than the one before as this could be a catalyst for a lot of the world implementing basic income.

If this coronavirus is cured by genetic engineering techniques, then the common cold, HIV, cancer, and much else will also be cured in short order, and the intense focus on treating coronavirus right now means it's not impossible or even unlikely that this could happen. A society with readily available genetic modification is quite different from this one and seriously accelerates singularity timelines.

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