Could the Coronavirus Cause an Economic Depression?

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Updated on Friday, April 17, 2020

As the coronavirus pandemic continues to upend the lives of Americans everywhere, the economic wreckage of shuttered businesses, increasing unemployment and a turbulent stock market could be enough to trigger an economic depression. While the U.S. government has stepped in to offer an assist in the form of a $2 trillion stimulus package that’s designed to help consumers and businesses alike stay afloat, economists acknowledge that a depression is still a possible outcome.

What is an economic depression?

While a concrete definition of an economic depression is hard to pin down, it’s commonly defined as a period of severe, widespread unemployment and significant standstills in economic activity. A depression is a more severe form of an economic recession, which is typically characterized by two consecutive quarters of declines in gross domestic product (GDP).

Common factors that can contribute to an economy falling into a depression may include a steep decline in stock market performance, widespread unemployment, sharply declining industrial production and severely slipping consumer confidence.

The difference between a depression vs. a recession

It’s worth highlighting that recessions are normal, downward trends in the typical business cycle that tend to happen right after a cycle reaches its peak and ends as it approaches its trough. Recessions affect everything from employment to GDP, and while they are painful, they have historically been brief.

Depressions, however, are a different animal. Depressions are much more severe forms of recessions, with GDP falling much more significantly and the effects spanning several years, as opposed to several months. During the Great Depression in the 1930s, for example, the U.S. lost 20% of its jobs over the course of three years, and the stock market dropped more than 80%. In contrast, unemployment is known to stay below 10% during recessions. Another key difference worth noting is that recessions tend to be more localized, while depressions can have a global reach.

Could the coronavirus cause an economic depression or recession in the U.S.?

Due to the surging unemployment rate and the plummeting economic output amid the coronavirus pandemic — similar to that of the Great Depression — some are bracing for an impending economic depression. While the International Monetary Fund (IMF) notes that a partial recovery is projected in 2021, “the level of GDP will remain below the pre-virus trend, with considerable uncertainty about the strength of the rebound.”

“Much worse growth outcomes are possible and maybe even likely,” said Gita Gopinath, the economic counselor at the IMF. “This would follow if the pandemic and containment measures last longer, emerging and developing economies are even more severely hit, tight financial conditions persist or if widespread scarring effects emerge due to firm closures and extended unemployment.”

However, whether the economic impact of the coronavirus pandemic will develop into a full-blown depression could depend on how both consumers and policymakers respond. Harald Uhlig, a professor of economics at the University of Chicago, acknowledges that while some sectors will continue to do reasonably well amid the pandemic, it’s hard to imagine a case in which it doesn’t result in a deep recession or even a depression.

“Economists need to sort out quickly what to do and why, as the core cause is quite different from, say, the house price plus subprime bust in 2008,” said Uhlig. “Making people go shopping downtown is clearly not the correct recipe right now, given the infection possibilities. I also do not believe that people would be willing to go along with a two-year economic shutdown, but this then risks a slide into that worst-case scenario as a result.”

Can an economic depression be avoided?

Uhlig says that it’s possible for the U.S. to do well, but for that to be the case, the virus needs to be contained. He also emphasized the importance of widespread testing and monitoring, and of taking the shutdown seriously.

Additionally, as the pandemic shutters businesses and keeps consumers at home, the IMF underscores the role of policymakers in keeping the economy chugging along.

“While the economy is shut down, policymakers will need to ensure that people are able to meet their needs and that businesses can pick up once the acute phases of the pandemic pass,” said Gopinath. “This requires substantial targeted fiscal, monetary and financial measures to maintain the economic ties between workers and firms and lenders and borrowers, keeping intact the economic and financial infrastructure of society.”

What is the economic impact of the coronavirus so far?

In its outlook released in April, the IMF announced that due to the coronavirus, it expects the world economy to contract by 3% in 2020, which it notes is far worse than the contraction that occurred during the 2008-2009 Great Recession.

Indeed, the U.S. economic impact of the coronavirus pandemic has been staggering. As of mid-April, unemployment claims have ticked up to nearly 17 million, the stock market has been rocked by extreme turbulence and global trade is deeply contracting.

“It is very likely that this year the global economy will experience its worst recession since the Great Depression, surpassing that seen during the global financial crisis a decade ago,” said Gopinath. “The Great Lockdown, as one might call it, is projected to shrink global growth dramatically.”

How to prepare for an economic depression

Only time will tell whether the COVID-19 pandemic will result in an economic depression. While you sit tight, there are steps you can take to make sure you are in your best position to financially weather an economic depression. This includes:

  • Making sure you have a healthy emergency savings fund
  • Cutting back where you can
  • Paying off high-interest debt
  • Reviewing your portfolio’s asset allocation, particularly if you’re retired and live off asset income

In fact, this actually could be a good time for consumers to look at their debt profile to find ways to save, such as through a mortgage refinance, or utilizing a balance transfer or personal loan to refinance existing credit card debt. Tendayi Kapfidze, the chief economist at LendingTree, points out that the increased liquidity from the Federal Reserve (a key part of the $2 trillion coronavirus stimulus package) should make borrowing cheaper for consumers.

Even in the case of an economic depression, Uhlig points out silver linings and the potential for new opportunities, noting that we will start to see a shift in certain sectors of the economy.

“Already, online retailers such as Amazon are hiring by the thousands,” Uhlig said. “While some firms disappear, new opportunities arise: Consumers still need to consume, life will go on. Get networked. Stay connected to friends and family.”

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