V, U or L

The Covid -19 pandemic has taken many lives and threatens many more, prompting an unprecedented policy response across the globe , generally intended to slow the spread of the virus and ‘flatten out the curve’ by reducing the risk of a short term spike in hospitalisations overwhelming the health system. Many economies, although not all,  are in various forms of lockdown and the economic impact will be severe, to an extent impossible to quantify with any degree of certainty, although in some cases data is now emerging which allows economists to make a stab at the impact.

Crucially though, a question which cannot be answered at this stage is how long the hit to economic activity will last. Stock markets have plummeted but the scale of the fall to date implies that investors are betting on a V shaped  recession i.e. a very sharp fall in activity for a couple of quarters, followed by a rapid recovery at least approaching  pre-crisis levels.That also seems to be the consensus view in terms of US analysts, with Goldman Sachs, for example, projecting a 1.5% fall in GDP in the first quarter, followed by a 6% decline in q2 and then a 3% rise in q3 and q4 . That leaves the average fall in  US GDP in 2020 at -3.8%, with a projected rise in the unemployment rate to around 9% from the current 3.6%.

The same  V pattern appears to be underpinning  expectations in the Euro Area (EA), although again the fall in annual GDP is huge. Germany. for example, appears to be  predicating its fiscal response to the crisis on a 5% fall in GDP. The March PMI for the EA (31.4) does provide sime guidance, with the average for the first quarter implying a 0.7% decline in  q1 GDP, followed by  around 2.7% in q2 if the PMI figure averages around 30  over the next few months. A 0.5% decline in q3 followed by a 1.5% bounce in q4 would leave the average fall in  EA GDP in 2020  at 2.5%.

In Ireland’ case the PMI indices do not correlate highly with recorded GDP but in any case we do not have a March reading anyway  so  we have little to go on in estimating the economic impact of the virus on the economy. Assuming a V shaped recession, however, with  heroic assumptions on the scale of very steep falls in non-food domestic spending till June,  yields a €10bn (9% )drop in consumption and a €15bn (8%) drop in modified domestic demand in 2020, assumimg a modest recovery in the latter part of the year.A similar  percentage fall in private sector employment would  push the average unemployment rate up to 12%. The impact on overall GDP largely depends on exports, however, including contract manufacturing, which amounts to some €70bn, with most originating in China. A collapse in that figure could throw up an enormous fall in recorded GDP but again if we assume that V shape for exports as a whole the overall fall in  fall in GDP is around 5%, which would be less than half the slump recorded during the financial crash because it would be short and sharp rather than over two years.

How long the recessions will last depends on the path of the virus and how quickly activity returns to ‘normal’ which are unknowns of course. So a U shaped cycle is certainly possible, with any material recovery in spending and output pushed out from two to say four quarters. That would clearly render the above estimates  very optimistic and pose big choices for governments in terms of fiscal supports designed to be short-lived.

Finally, there is also the prospect that the virus takes much longer to pass through the population and that the return to ‘normal’ patterns of social and economic activity does not occur for  a prolonged period, giving an L shaped cycle i.e. any upturn takes well  over a year to eighteen months to materialise. Clearly that would result in much steeper falls in  equity markets than seen to date, much larger increases in unemployment, massive credit issues and much larger fiscal hits to governments. Of course we have seen unprecedented levels of policy response on the monetary side, designed to pump liquidity into the system and limit the scale of any rise in long term borrowing cost for governments. Media headlines have also highlighted huge fiscal ‘stimulus’ packages but to date most of this relates to State guarantees for bank loans, which may carry fiscal  implications down the line but is effectively monetary in seeking to supply credit to the business sector. Nonetheless, we have also seen governments now also turning to more direct measures , including enhanced unemployment assistance and in some cases, including Ireland, wage support. As yet these massive increases in fiscal deficits are seen to be financed by borrowing rather than money creation, albeit with the resumption of QE in many cases meaning that  the private sector will not be alone in buying the debt.

Irish household savings ratio continues it decline

The household savings ratio, the percentage of disposable income not spent on personal consumption, can be seen as a residual in the national accounts and in Ireland’s case is subject to sizeable revisions. Consequently it is not a robust  base for an economic projection yet many  forecasts are in part predicated on changes in the ratio and the widely held expectation that Irish consumer spending will pick up this year and next  explicitly or implicitly assumes a fall in the ratio i.e. that households will make a conscious decision to spend more from a given income. In fact, as the latest CSO figures reveal, the ratio has been falling steadily since 2009, and that against a backdrop of a declining trend in consumer spending.

The CSO figures refer to gross savings which are defined as that fraction of gross disposable income not spent, so it does not equate directly with a flow of money into savings products. The use of income to repay debt, for example, would class as saving on that definition, and we know from other sources that households have in fact been deleveraging for some time. The decision to save is also likely to be influenced by a host of other factors including interest rates, changes in the tax system, inflation and the state of the economy, with high and rising unemployment often seen as a catalyst for higher savings as households react to uncertainty. Similarly, an improvement in the economic climate and a decline in unemployment is viewed by forecasters as likely to precipitate a fall in the savings ratio and hence generate a rise in consumer spending above that indicated by the change in disposable income.

Gross savings fell in Ireland  at the peak of the boom, declining to under €6bn in 2007, but rose sharply over the following two years following the onset of the economic and financial crisis, exceeding €15bn by 2009. Savings in that year amounted to over 16% of disposable income (against a ratio of only 6% a few year earlier) but  the ratio declined steadily from there and fell back into single figures last year, at 9.4%.

The actual amount saved annually has also fallen steadily, to just over €8bn last year, but Irish households have also seen a significant decline in disposable income , which fell again marginally in 2013 to under €87bn from a peak of €102bn in 2008. Consumer spending has also fallen since the peak of the boom and the decline is therefore not driven by a rise in household saving- the weakness in consumption over recent years clearly reflects pressure on household incomes rather than any surge in precautionary savings. Indeed, the  fall in the savings ratio can be seen as households seeking to contain the fall in consumption by dipping in to savings.The savings ratio is still higher than it was prior to the crash, it must be said,  but is probably not the font for additional spending envisaged by many forecasters, including the IMF. The scale of data revisions also cautions against hanging any projection for an upturn in consumption on a change in the ratio.