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COVID-19 pandemic creates fears that may constrain economic growth



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Although no country in the world has a gold standard, gold is still needed for the economy, especially now in the middle of the pandemic.

USA TODAY

The nation is awaiting a vaccine that can halt the COVID-19 pandemic in its tracks, allowing life – and the battered U.S. economy – to return to normal.

But a new study suggests the crisis has generated fears that are likely to dampen risk-taking and economic output for decades by increasing the “perceived probability of an extreme, negative shock in the future.” Over time, the economic cost of that warier outlook is “many times larger” than the short-term damage, the study says.

The study, titled, “Scarring Body and Mind: The long-term belief-scarring effects of COVID-19,” attempts to quantify such long-term economic losses by assessing the toll taken by other economic upheavals, such as the Great Recession of 2007-09.

“While the virus will eventually pass, vaccines will be developed, and workers will return to work, an event of this magnitude could leave lasting effects on the nature of economic activity,” says the paper, which was released at the Federal Reserve Bank of Kansas City’s annual conference last week. “Businesses will make future decisions with the risk of another pandemic in mind.”

A riskier world than we thought

Consciously or subconsciously, firms will likely fear the possibility of not just viral outbreaks but other unforeseeable events that could upend the economy and their business plans, the study says.

“We learned that the world is riskier and more unpredictable than we thought,” the report says. “The shocks that hit one sector may hit another tomorrow, in ways that are impossible to foresee.”

Think of a child who touches a hot stove or suffers abuse. “A child who is mistreated becomes very afraid of a lot of things,” says study co-author Laura Veldkamp, a finance and economics professor at Columbia Business School. “We’ve learned that really risky stuff can happen.”

The study comes as Congress remains deadlocked over another stimulus package that would provide lifelines to unemployed workers and small businesses on the brink of failure. Such assistance could go a long way toward curtailing not just short-term economic losses but the long-run casualties fostered by more skittish investors, the paper says.

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“Preventing bankruptcies or permanent separation of labor and capital could have enormous consequences for the value generated by the U.S. economy for decades to come,” the paper says.

Economy shrinks at record pace 

The pandemic led states to close down restaurants, malls and other outlets across the country to minimize contagion. Although businesses are reopening in phases, flare-ups, particularly in the South and West, prompted nearly half the states to pause or roll back reopening plans. The economy contracted by a record 31.7% at an annual rate in the second quarter and shed an unprecedented 22 million jobs before recovering 9.3 million positions from May through July as shuttered businesses reopened and brought back at least some workers.

Several top economists believe as much as half the temporary job losses and furloughs could become permanent and thousands of businesses could go bankrupt. Moody’s Analytics doesn’t expect the economy to recoup all the jobs lost in the crisis until late 2023. The Fed paper, however, looks beyond even such longer-term damage to gauge the more nuanced toll caused by altered perceptions and reduced investment years and decades from now.

For example, the pandemic is making certain “capital” – such as equipment and buildings – obsolete, depreciating their value. Restaurants are closing or using just a portion of their capacity. Offices sit empty as more people work from home. And many cruise ships will never sail again.

 In a normal economic cycle, such idle capital eventually would be replaced by new assets that generate similar or even greater output. The study, however, finds that the lingering caution among investors spurred by the crisis will leave a gap that keeps the production of goods and services well below what it otherwise would have been. And fewer machines or buildings in use means there’s less need for workers to run the assets.

Similarly, widespread defaults and bankruptcies discourage entrepreneurs from starting new businesses, the paper says.

Worse than Great Recession?

The study examined the long-term scarring effects of events over the past 70 years, such as the oil crisis of the late 1970s, the early 1990s recession and the Great Recession, which by far led to the most severe long-term fallout, Veldkamp says. Yet it found that the coronavirus crisis will result in even deeper long-term damage.

The long-run effects are nearly 10 times the projected 6% to 9% decline in U.S. gross domestic product this year, the study says, with changes in beliefs accounting for most of that drop. Depending on whether the U.S. has just one or multiple lockdowns, the lasting effects of the crisis are likely to reduce economic output over 70 years by the equivalent of 57% to 90% of a year’s worth of GDP pre-COVID, the paper says.

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That translates into millions fewer jobs created, Veldkamp says.

“This is worse than the Great Recession,” she says. “It’s certainly more sudden, and part of the suddenness is the shock value.”

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