'Deeper depression unlikely, expect U-shaped recovery post COVID-19'

VK Vijayakumar

As the COVID-19 crisis lingers taking lives and hitting the global economy hard, many experts are predicting a dooms day scenario. Some have gone to the extent of describing the present crisis as a potential 'Greater Depression'.

The Great Depression of the 1930s at its peak led to 25 percent unemployment and 30 percent contraction in GDP in the US. This was, of course, the worst economic catastrophe of modern times. The Global Financial Crisis of 2008 and the Great Recession that followed was the worst crisis after Great Depression.

During that crisis also many experts had predicted that the global recession might aggravate into another depression that might last for several years. But this didn't happen. The unconventional ultra-loose monetary policy implemented by the leading central banks of the world facilitated a strong economic rebound. The US, particularly, experienced the longest period of economic expansion in history spanning more than 10 years.

It is true that the present unprecedented 'Great Lockdown' has caused global unemployment, which is presently worse than that of the Great Depression. But this is forced unemployment; not the unemployment caused by economic collapse. Once the lockdown is lifted, unemployment will decline drastically. The unprecedented fiscal and monetary measures being implemented globally can prevent a Greater Depression.

Monetary mismanagement during the crisis of 1930s

There is a near consensus among economists that the stock market crash of 1929 and the recession that followed aggravated into a depression due to monetary mismanagement. Fiscal stimulus as a counter-cyclical policy was unknown until Keynes popularized fiscal policy through his magnum opus ‘The General Theory of Employment, Interest and Money’ in 1936. In the initial years of the Great Depression President Hoover was trying to balance the budget.

And the Fed, adhering to the Gold Standard, didn’t expand money supply. In fact during 1930 to 1934 money supply in the US contracted and deflation led to very high real interest rates. At the peak of the Great Depression in 1932 deflation was 10.7 percent and real interest rate was 11.49 percent. The conservative Fed believed that bank failures are necessary for the stability of the financial system and allowed one third of the banks to fail. People started hoarding cash.

Massive unemployment and hoarding of cash caused collapse in aggregate demand, triggering a vicious cycle of falling investment, rising unemployment, declining aggregate demand and collapse in growth.

The present scenario is different

The present economic crisis caused by the Great Lockdown is unprecedented and hugely different from the Great Depression. The leading central banks, through Quantitative Easing, have ensured historically low interest rates - both nominal and real. Globally fiscal stimulus is at an unprecedented high level. This certainly will produce unintended negative consequences later. But for the present, the top priority is preventing an economic collapse.

Economies will have to open up, whether the virus subsides or not. Present indications are that infections and mortality will peak in May facilitating phased opening up of economies. If that does not happen we will have to learn to live with the virus. Extended lockdown is not an option since that will prove to be a remedy worse than the disease. Economic recovery will not be V shaped; but a flat U shaped recovery is possible given the massive global fiscal stimulus and historically cheap money.

The author is Chief Investment Strategist at Geojit Financial Services.