Clear-cut policies essential to accelerate economic recovery

Economic opinion

The low point of the Covid-19 economic crisis is behind us. The current global resurgence of infections lacks the power to cause the same economic damage as it did in the first half of 2020. Milder government measures, but also a remarkably strong resilience among consumers and businesses, ensures that the recovery will be lasting. Yet it is too early to cheer in victory. The recovery is fragile and will therefore take a long time, not only because of the resurgence of the virus, but also because confidence in the economy is currently on shaky ground. That confidence is undermined by a lack of clear-cut policymaking. Despite a strong monetary and fiscal stimulus, the recovery risks being slow.

 

The post-corona world

The coronavirus surprised in terms of both the size and speed of its economic impact. Central banks reacted remarkably quickly, thanks to their recent experiences with the financial crisis and the European debt crisis. Crisis management is part of the DNA of every central banker today. The latter does not apply to all policymakers. Confronted with the first pandemic in decades, and inspired by the reactions of other countries (in particular China) and recommendations from the World Health Organisation (among others), many countries opted for a particularly harsh approach: lockdowns that de facto paralysed economic activity to a large extent. As the disastrous economic impact of such measures became clear (among many other side-effects), many governments rushed to reduce the lockdown measures, opening the door to new virus outbreaks. Since then, policymakers have been trying to strike a balance between avoiding health risks on the one hand, and maintaining the economic recovery and the mental well-being of young and old on the other, with an increasing focus on a return to the 'normal life' of yesteryear.

The question is whether that 'normal life' will return sooner or later. The unexpected and changing policy actions fundamentally affect the confidence of citizens and businesses. Sentiment indicators tumbled at the start of the crisis but recovered just as spectacularly when the drastic lockdown measures came to an end and the economic recovery simultaneously took hold. In some countries we are now seeing a full recovery in confidence indicators, while in others, the recovery is unfinished but nevertheless far-reaching. Still, it is an illusion to think that confidence has fully returned. A more realistic estimate is that citizens and businesses are uncertain about the future and will therefore be cautious in their consumption and investment. This creates a disastrous vicious circle. The economy needs confidence to recover structurally, but confidence can only recover in a favourable economic environment. In order to break this circle, resolute policy is needed. And that's where the shoe pinches...

Choice stress

After all, policymakers are reluctant to opt for a specific post-corona strategy, sometimes for political reasons, but even more so as the result of many different and justified considerations. Developing a balanced policy is not easy and it is quite understandable that good policymakers hesitate in their decisions. However, this hesitancy contributes significantly to uncertainty and thus to a slowdown in the economic recovery. Confidence is the essential building block for economic recovery, including for generating new jobs, new investments and strong consumption growth. Confidence-building policies, even regardless of their precise content, is what we need for the near future.

Brexit is back

Clear-cut policymaking is therefore essential in the near future. This applies not only to Covid-19 issues, but to all policy areas. For example, brexit-chaos is flaring up again. Boris Johnson's threat, in the absence of an agreement with the EU by 15 October, to opt for a no-deal brexit, brings high tension to the negotiating table. Nevertheless, we believe that this shock therapy will contribute to a solution rather than pose a problem. Moreover, the economic damage of a hard brexit would be limited compared to the dramatic impact of the corona crisis. Our simulations show that in the current circumstances a 'hard brexit' would additionally cost between 0.5% and 2% of growth to the EU member states, with the greatest negative impact on Ireland, the UK's main European trading partner. Of course, it is best to avoid such an additional shock and delay in the recovery. But the damage of permanent brexit uncertainty may be greater than the damage of a no deal brexit. As such, it is time to turn the brexit page. The rudderless brexit negotiations have lasted long enough.

Because of the risk that policies at the national and European level will not provide the necessary clarity, we remain cautious in our forecasts for future economic growth in the eurozone. A further recovery is written in the stars, but we remain cautious in our optimism. In concrete terms, real GDP in the eurozone is expected to shrink by 8.3% in 2020. The recovery in 2021 will be limited to 5.2%, so it will take until 2023 for the European economy to fully recover from the corona shock. This annual growth pattern assumes quarterly growth of 6.7% in the third quarter of 2020 and 4.5% in the fourth quarter. In absolute terms, this seems like a bright future, but more is needed to claim the economic victory over the Covid-19 virus.

 

 

Disclaimer:

Any opinion expressed in this KBC Economic Opinions represents the personal opinion by the author(s). Neither the degree to which the hypotheses, risks and forecasts contained in this report reflect market expectations, nor their effective chances of realisation can be guaranteed. Any forecasts are indicative. The information contained in this publication is general in nature and for information purposes only. It may not be considered as investment advice. Sustainability is part of the overall business strategy of KBC Group NV (see https://www.kbc.com/en/corporate-sustainability.html). We take this strategy into account when choosing topics for our publications, but a thorough analysis of economic and financial developments requires discussing a wider variety of topics. This publication cannot be considered as ‘investment research’ as described in the law and regulations concerning the markets for financial instruments. Any transfer, distribution or reproduction in any form or means of information is prohibited without the express prior written consent of KBC Group NV. KBC cannot be held responsible for the accuracy or completeness of this information.

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