The world is suffering a pandemic that led to an unprecedented economic stop in many countries, and uncertainty persists about when normality will be recovered. According to our estimates, the Eurozone is likely going to be the most affected region, and the reaction of some of its main partners can lead to stagflation and even the risk of a banking crisis. The United States will also be hit, but due to its flexible economic structure we expect a faster recovery, with China and the main Asian economies recovering strongly.
The measures taken by governments and central banks are also unprecedented. As such, we warn about the high risks of placing the entire burden of the crisis and the recovery on an already challenged banking sector through large loan programs to troubled businesses that may lead to significant solvency and liquidity challenges in the mid-term as non-performing loans will likely rise. We would also like to warn about large spending and stimulus packaged in a prolonged and forced shutdown of the economy that may have long-lasting ramifications. Incentivizing demand through fiscal and monetary policies might create a double challenge: Function as a subsidy to sectors that already had overcapacity and sustainability issues while not reaching the small businesses that have no access to credit and collapse with no sales and job losses.
We believe that unprecedented challenges merit unprecedented measures, but also think that there may be a risk of implementing large stimuli too early, Government stimulus programs may be targeting the wrong parts of the economy, and a selective and carefully analyzed combination of policies throughout a longer period of time may work more effectively.
In this scenario, it is important to consider that large fiscal and monetary stimuli have proven to be less effective than expected in the past during a growth period, and that the world faces an unprecedented supply shock added to a forced shutdown of the economy where incentivizing demand is unlikely to reduce the output contraction and very unlikely to be followed by supply. We must alert of the risk of some of these policies creating more stagnation risk and deflationary pressures.
We believe that combining government plans with supply measures and especially reallocation of spending added to tax exemptions and deferrals can help significantly in this crisis.
References and further reading:
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