This blog post gathers a few macroeconomic forecasts for the current and upcoming years from different sources and tries to piece together a view of what we may have ahead of us in terms of GDP growth, output gaps, and inflation.
According to the IMF World Economic Outlook (WEO), most advanced economies are expected to have a negative GDP growth rate of about -5 to -10% in 2020. GDP in the Eurozone, for example, is forecasted to be some 8% lower this year compared 2019.
This is completely unprecedented for the entire postwar period. For comparison, during the Great Recession in 2008/2009, advanced economies recorded a GDP decline of about 3%, on average.
Obviously, back then, just as now, some economies were hit much harder than others. The big difference was that in 2008/2009, Emerging Markets were still recording positive growth rates, meaning that the global economy actually did not shrink during the Great Recession.
This time will unfortunately be different.
First, some Emerging Markets already had somewhat weak fundamentals going into this crisis, especially Argentina, which was already suffering from negative growth, a worsening current account, and extremely high inflation.
Even though some advanced economies have not exactly covered themselves in glory when it comes to the Corona response, it is undeniable that many Emerging Markets are lacking the state capacity, an adequate health care system, the necessary public finances and domestic resources in general to deal with the current pandemic.
Given that the pandemic’s current spread in Latin America, and the vulnerability that many African countries and parts of Asia are facing, Emerging Markets will not be able to save the global economy this time around.
In fact, the current IMF forecast shows a negative growth rate of more than -1% for the entire group of Emerging and Developing Economies while global GDP is expected to shrink by some 3% in 2020.
The IMF does forecast a sizeable rebound in 2021, but it will not even get us back to the Q4 2019 level of GDP.
Oxford Economics predicts that Q4 GDP 2020 will be some 5-8% lower than Q4 GDP 2019, combined with a sizeable rebound in 2021. These projections do not suggest that most countries will be able to reach their previous GDP peak by the end of 2021.
Last but not least, the table below displays the OECD forecasts. Instead of producing a single point estimate, which in my opinion is somewhat nonsensical (right now) with the amount of uncertainty we currently face, the OECD has produced conditional forecasts instead.
The left hand side of the table (and the bars in the graph) display the GDP forecast under a “double hit” (DH), assuming a second wave of Corona will hit us at the end of the year.
The table also contains the “single hit” forecast (SH) and the difference (Delta) between the two projections.
The double hit scenario would be truly awful as forecasters expect that 2020 GDP would be some 15% lower compared to the previous year in the Eurozone, -13% for the US, and some -10% for a number of Emerging Markets.
The graph below displays the level of GDP instead of the growth rate for advanced economies. As one can see, even by the end of 2021, most economies will not have reached the 2019 level of GDP in a double-hit scenario.
Besides China, which is expected to grow moderately, the outlook for Emerging Markets is just as awful.
The key takeaway from all of this, and especially the OECD projections, should be that there is considerable uncertainty about the economic outlook, more than ever before. Usually, the degree of uncertainty should increase the further you make projections out into the future. However, right now we truly live in a period of Knightian uncertainty as a result of this pandemic. Consequently, the standard deviation for the GDP forecast from Consensus Economics is actually highest for this year and the next, and decreases from 2022 onwards.
Compare this to the GDP growth forecast from July 2019 before the pandemic where the standard deviation of the forecasts display the expected upward trend for the first years out.
Output gap projections are also pointing towards a gloomy picture. The Oxford Economics data suggests that most advanced economies will operate some 6 to 10% below potential in 2020, and significant output gaps remain in 2021 and beyond.
Similar to the aftermath of the Great Recession, most advanced economies are expected to operate below full capacity for a rather long time. Furthermore, there is reason to believe that current output gap projections are somewhat flawed and underestimate the severity of the problem.
Let’s consider the output gap estimates put forward by the European Commission (Ameco) for the European countries and the UK and the US.
Potential output is quite often still estimated with statistical filters, such as the HP filter, for example. The flaw here is that the properties of the HP filter automatically lead to positive output gaps before any given downturn and subsequently also underestimate the actual output gap during a recession and its aftermath.
As I have argued before, this extremely problematic. Back in 2019, we certainly did not think that advanced economies are operating far above potential. Regardless, the Ameco estimates now show that countries like the Netherlands, Spain, and the US were operating 1.5%, 2.3%, and 2.6% above potential.
It would be more sensible to assume that the economy was operating at or close to potential in 2020 and revise the negative output gaps downward for this and all subsequent years.
While I have talked a lot about growth forecasts and output gaps, inflation projections and the outlook for interest rates has been also revised downwards considerably, consistent with the effects of a huge global negative demand shock.
Consequently, the Fed estimates that it will likely be constrained by the effective lower bound on interest rates throughout 2022. This is certainly very plausible since the entire global economy is trapped in a low interest rate regime.
While the pandemic is also damaging supply, the nominal effects will turn out to be much more disruptive than the real effects.
Interest rates are projected to stay low for even longer. It looks like the Covid shock will turn out to be worse than the Great Recession, and aggravate many problems of secular stagnation: low equilibrium interest rates, high asset prices, high inequality, a low labor share, and a low pressure economy for years to come.
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