After the pandemic: Medium-term growth uncertainties

• ▪ The coronavirus is having a very large short-term negative impact on world growth. But the medium-term growth outlook is more uncertain. Much depends on the policy response - a strong and well-designed response could contain the medium-term output losses, but large and enduring damage is a risk.
• ▪ Growth patterns after significant GDP declines vary. Historical evidence points to large upfront effects from pandemics and natural disasters, but the medium-term outcomes are mixed, with policy responses a crucial determinant. Longer recessions and financial crises tend to lead to weaker medium-term growth.
• ▪ The coronavirus may trigger annual GDP declines among the worst seen in the last 100 years. Economies can bounce back sharply after such declines, but our analysis suggests output losses also endure in a significant number of cases.
• ▪ The US interwar experience shows the danger of allowing financial distress to snowball and exacerbate GDP declines. The weakness of medium-term growth after the global financial crisis confirms the long-term impact of such distress.
• ▪ A key risk for the medium term is that firms and/or households react to the coronavirus recession and disruption by raising savings, accelerating a shift toward ‘Japanification’ of major economies.
• ▪ Our baseline forecasts envisage moderate medium-term output losses due to coronavirus, in part reflecting rapid and large-scale policy interventions. But uncertainty around this forecast is significant and considerable variation is possible across economies.

     

Coronavirus: Short-term pain but strong rebound likely

• ▪ Attention has understandably focused on limiting the damage from the short-term effects of the coronavirus outbreak. But it's likely that, once disruption and uncertainty fade, the rebound in activity will be strong. It's important for firms to position themselves for such a recovery.
• ▪ Historical evidence supports this view. In the past 200 years, short recessions have typically been followed by robust recovery. Long-term impacts from natural disasters have generally only been evident for specific hazards. Except for AIDS, longer-term pandemic effects also appear to have been contained.
• ▪ Surveys during the 2003 SARS and 2009 influenza outbreaks highlight one explanation for time-limited impacts. Public fears increased alongside rising infection rates, but they dissipated promptly as outbreaks came under control.
• ▪ Our modelling is consistent with these stylised facts. In our coronavirus pandemic scenario, global growth grinds to a halt in Q2 2020 but then rebounds to a rapid pace within a year. With much of the initial output loss recovered in a relatively short period of time, long-term impacts are limited.
• ▪ But there are risks to this view. The period of disruption could be longer than anticipated, depending on the potential spread and seasonality of COVID-19 and policy actions to mitigate the fallout. Opinion polls also highlight the potential risk of larger, more persistent effects for some countries.
• ▪ Moreover, coronavirus-related weakness and associated financial distress could expose other key vulnerabilities - for example related to deteriorating corporate sector balance sheets and fragile trade relations. These would be expected to have persistent effects on global activity over the coming years

     

The economic cost of coronavirus lockdowns

• ▪ Widespread lockdowns and social distancing in economies affected by the coronavirus outbreak are set to cause a massive negative short-term impact on consumer spending and GDP.
• ▪ A large chunk of consumer spending is discretionary and so is very sensitive to being postponed or lost completely due to quarantines and social distancing.
• ▪ The early evidence from China supports the idea that up-front effects will be large, with retail sales down 20% y/y in January–February and industrial output over 13% lower, thanks to widespread factory closures.
• ▪ We estimate that a three-week lockdown affecting 50%–90% of a population would cut consumption in the three–month period featuring such a lockdown by 5%–8%, a six-week lockdown by 9%–16%, and a 12-week lockdown would slash it by 18%–32%.
• ▪ Full-year effects depend on how quickly postponed consumption revives as outbreaks come under control. But even quick recoveries imply big full-year losses: An initial 18% slump in consumption would still imply a full-year loss of 9%, even if spending recovered to pre-pandemic levels in four quarters. If recovery took eight quarters, the full-year loss would be an enormous 14%.

     

Why levelling-up is unlikely to solve regional disparities

• ▪ Under the UK government's plan to “level up” the regions, the Budget delivered an increase in capital spending on under-performing places. However, we think the overall impact is unlikely to be large.
• ▪ The extent to which regional imbalances have worsened in recent years is unclear. In fact, the large gap in productivity between London and the rest of the UK widened the most during the 1997–2010 Labour government. Disparity with the rest of the UK is largely due to London's special characteristics.
• ▪ At the local level, austerity policies have damaged many areas, while Brexit is posing new challenges. Other problems are very deep-rooted. Previous governments have struggled to address them and we expect this one will too

     

BoE financing of the government deficit is no longer taboo

• ▪ The BoE has hinted that it could directly finance the government's soaring deficit. While there is no urgency to do so at present, BoE purchases could calm potential disruption in the gilt market and be a strong economic support.
• ▪ Direct money financing by the UK central bank would be a radical approach, but not unprecedented. However, it's necessary to go back to 1914 to find the last episode when the BoE took on the role of funding public borrowing.
• ▪ Once normality returns, money financing could result in a rise in prices. But a time-limited expedient shouldn't result in persistent inflation. And policymakers could seek to unwind the BoE's money creation.

     

Fixed versus floating: vulnerability to rising interest rates

• ? Looking at different economies' exposure to fixed‐ and floating‐rate private‐sector debt reveals how vulnerable they could be to rising interest rates. Our analysis finds that Hong Kong, Sweden, China and Australia are potentially most exposed via floating rates to rising debt service costs. A 150bp rise in rates would also push several other countries' debt service ratios above the peaks of 2008. Less vulnerable economies include the US and Germany.
• ? High levels of floating‐rate debt imply a large and rapid pass‐through of rising interest rates to firms and households, with negative consequences. Exposure to floating‐rate debt as a share of GDP varies greatly: the highest levels are in Hong Kong, China, Sweden, Australia and Spain, with the lowest levels in the US, France and Germany.
• ? Growing shares of fixed‐rate housing debt in the US, Eurozone and UK mean the impact of higher interest rates may be less severe than a decade ago. Private deleveraging in countries such as the US, UK and Spain could also soften the impact.
• ? A rise of 100bp in short‐term interest rates would raise the debt service ratio after one year by around 2.5% of GDP in Hong Kong, with increases of 1.5–1.7% of GDP in Sweden, China and Australia. The smallest effects would be in the US and Germany.
• ? A 100–150bp rate rise would push debt service ratios in China, Hong Kong, Canada, France and the Netherlands well above their peaks of a decade ago. A similar rate rise would take debt service ratios in Sweden, South Korea and Australia close to, or above, previous peaks.
• ? The distribution of debt within economies, which our analysis does not cover, is also important. For example, there is some evidence that the US corporate sector has a high concentration of debt among borrowers with weak finances. Countries that are highly vulnerable to interest rate rises may see their central banks normalise policy rates more slowly than they otherwise would.

     

Productivity – your countries need you!

• Increased global productivity could boost real wages, consumption, fiscal positions and alleviate fears of secular stagnation. But will it? Puzzles relate to the longer term global slowdown and to some countries' recent productivity‐less recoveries in jobs. We assess various explanations including mismeasurement, secular stagnation, financial sector malfunction and increased labour market flexibility. Our baseline forecast is for a moderate pro‐cyclical recovery in productivity but we show how downside risks imply it could be anaemic.
• Sustained weak productivity is a secular issue. Eight years after 2007, median productivity growth in OECD economies is less than Japan's was eight years into its lost decade. Aspects of secular stagnation and balance sheet adjustment have contributed. Measurement error may have played a role over the longer term.
• Recent experience divides recoveries into “haves” and “have nots” in terms of productivity and employment. The UK may finally be emerging from a “productivity‐less” recovery in employment after 2011; Spain and the Netherlands have experienced jobless recoveries in productivity; others, such as Canada and Sweden, have experienced pro‐cyclical (typically weak) recoveries in productivity; Italy hardly got going in either direction.
• Most theories provide, at best, a limited explanation for recent weak productivity performance. These include data mis‐measurement, increased labour market flexibility, financial sector malfunction and supply side secular stagnation.
• On balance, we think that a modest productivity bounce‐back could be imminent, caused by some demand recovery, tighter labour markets in major economies, higher real wages and firms deciding to invest more in capital, which enhances productivity and points the global economy towards normality.
• We also illustrate how global risk scenarios could dampen recovery. Negative skews imply mean G7 productivity growth across the scenarios would be an anaemic 1.1% in 2016, 0.5 percentage points (pp) lower than the baseline.

     

World Economic Prospects

Overview: World growth cut as financial woes persist

• This month sees our world GDP forecast for 2016 cut to 2.3%, from 2.6% previously. Our new forecast implies this year will be the weakest for the world economy since 2009.
• Our 2016 growth forecast was over 3% in mid‐2015. But the economic backdrop has worsened markedly since, with steep drops in stock markets, slumping commodities and widening credit spreads.
• We flagged the risks from the financial market sell‐off last month and conditions have improved little since. Worse, there are some signs that weakness in the real economy may be broadening.
• This month's global downgrade partly reflects familiar factors such as worsening emerging markets: we now expect even deeper recessions in Brazil and Russia.
• The US forecast has also been downgraded again, to 2% from 2.4% last month. This in part reflects a soft Q4 GDP reading, one worrying detail of which was a weaker performance by consumer spending.
• Signs of a slowdown in services were also visible in the PMI surveys for January in the US and Eurozone. Partly as a result, our Eurozone growth forecast has been cut this month to 1.6% from 1.8%.
• With world industry already stagnant, signs of weakness spreading to services are unwelcome. We are particularly concerned that the financial market slump will create a negative global credit and confidence shock.
• Another concern is that the collapse in world stock prices is starting to have ‘negative wealth effects’. For most consumers, wealth effects are more likely to be generated by house price moves. In this respect, there is some room for optimism – house prices are still growing in most of the main economies.
• But housing is weakening in some emerging countries and world house and stock prices have tended to move together since 2007.
• Pressures on policymakers to act remain strong and are increasingly focused on using negative interest rates – as in Japan and Sweden in the last month.

     

Spillovers among CDS indexes in the US financial sector

By employing the robust cross-correlation function approach proposed by Hong (2001), and conducting pre-tests for structural breaks in the variances as well as removing the causality-in-mean effects in the causality-in-variance tests, we investigate volatility and mean transmissions between the credit default swaps (CDS) indexes of three US financial sectors. We use daily series on five-year banking, insurance, and financial services sector CDS indexes at the sector level from January 2004 to December 2011. We find evidence of significant causality-in-mean effects running from the banking sector to the insurance and financial services sector CDS indexes and from the financial services to the insurance sector CDS indexes, suggesting the leading role of the banking and financial services sectors in terms of price discovery. Moreover, we find significant causality-in-variance effects from the financial services sector CDS index to that of the banking sector, implying the existence of information transmission and contagion from the former, the least regulated of the three. The implications of these findings on traders and policymakers are also provided.     

Brewed for decades: Cyprus' perfect financial storm

• The Cypriot banking catastrophe was a momentous point in economic history at which a tiny island suffered such acute financial distress that it shook the entire Eurozone. Here we trace how Cyprus go to that point, via a series of mishaps and misjudgements, and missed escape routes going back over four decades.
• Cyprus will go down in history as one of the closest there has ever been to a perfect storm of financial instability, brewed from terrible decisions by its banks, supervisors and politicians; compounded by rotten luck and bad timing. Even Cyprus’ political and financial strengths made things worse by delaying firm action and allowing losses to build. Most imaginable horrors that could happen to a banking system did happen, and that was even before the controversial and partially botched international rescue operation.
• It was an international crisis in many senses of the word. The crisis was hosted in Cyprus, massively escalated by events in Greece, and paid for in large part by Russian depositors.
• There are lessons for Greece, but the experiences also have important differences. Crucially, there was a strong constituency in Cyprus to support painful austerity and structural reforms necessary to get rid of capital controls. That does not exist in Greece.
• The dramatic unfolding of events on the night of 15 March 2013 also provides a lesson that was not heeded in Greece. All‐night negotiating sessions against hard‐deadlines tend to lead to highly flawed agreements, though they are also a symptom of such commitment to the euro that things might work out in spite of the flaws.

     

World Economic Prospects Monthly

Overview: Market falls overstate loss of momentum

• ? Financial market moves in recent months suggest that there is increasing concern about a substantial global growth slowdown or even a recession. But we continue to see this as an over‐reaction to the weakening economic data; while the downside risks to the global GDP growth outlook have clearly risen, our baseline forecast for 2019 is little changed at 2.7%, down from 3% in 2018.
• ? Recent economic news confirms that the Q3 economic soft patch appears to have spilled over into Q4, particularly in the industrial sector which has seen a broad‐based loss of momentum in many economies coinciding with a further slowdown in global trade growth. But while surveys of service sector activity have also moderated, the falls have been rather less abrupt, suggesting that overall global GDP growth is slowing albeit not alarmingly so.
• ? On balance, we think that the weaker data do not provide compelling evidence that global growth is slowing more sharply than our December forecast. Although the financial market sell‐off and associated tightening in financial conditions will impinge on growth, this may at least be partly offset by weaker inflation in response to lower oil prices, now seen at US$61pb in 2019. This, combined with the continued strength of labour markets and the likelihood of further moderate wage growth, points to a further period of solid household spending growth.
• ? Nonetheless, the risk of a sharper slowdown has risen. Cyclical risks have increased over the past couple of years as spare capacity has diminished. And uncertainty over the economic and financial market impact of the unwinding of central balance sheets have added to the risk of policy mistakes.
• ? Although our central view is that the recent financial market correction will not morph into something rather nastier, further sustained weakness (particularly if accompanied by dollar strength) would have more significant implications for activity and could see world growth falling below the 2016 post‐crisis low of 2.4%.

     

Efficiency in Third Sector Partnerships for Delivering Local Government Services: The role of economies of scale,scope and learning

Abstract

Third sector partnerships are under pressure to change in the light of the increasing cost pressures on local public services. The literature throws doubt on the level of economies of scale and suggests that more attention should be given to economies of scope and learning. The common conflation of economies of size with economies of scale has led policymakers to overemphasize larger scale providers and has distorted the strategies which third sector organizations have adopted, pushing them towards mergers and consortia based on scale.     

Are central banks really breaking the (policy) rules?

• ? Looking at the strength of the global economy, it's no surprise that simple policy rules suggest that interest rates in some advanced economies are much too low and/or that several rate hikes would be needed in 2018 to avoid falling further behind the curve. Nonetheless, we expect central banks to respond cautiously and we see a slower pace of tightening than the consensus view .
• ? Policy rules, such as the Taylor Rule, have long been considered a useful guide to the potential path for policy rates. But while it suggests that current US, Eurozone and Australian central bank rates are broadly appropriate, it signals that UK, Canadian, and Swedish rates should be substantially higher. Based on our economic forecasts, Taylor Rules suggest that the central banks in the US, Eurozone, Canada and Australia will all need to raise intertest rates by around 100bps by end‐2018.
• ? However, there are several reasons not to draw strong conclusions from such point estimates. First, the Taylor Rule requires estimates of two unobservable variables – the output gap and the natural rate of interest – which cannot be estimated precisely.
• ? Second, using models that were designed to predict US policy responses in the 1990s to forecast central banks' behaviour today is likely to be misleading. Meanwhile, inferring central banks' reaction functions from recent policy rate moves to assess the future policy path is fraught with difficulties. Not only have interest rates been broadly unchanged for the bulk of the post‐financial crisis period, but policymakers have provided other forms of policy support.
• ? Third, outside the US at least, Taylor Rules have historically pointed to persistently different policy rates from those observed, yet inflation has been well anchored.
• ? The upshot of all this is that we expect central banks in the advanced economies to err on the side of caution and anticipate interest rates rising less quickly than the consensus amongst economists.

     

The effect of economic growth on banking system performance: An interregional and comparative study of Sub-Saharan Africa and developed economies

As an important part of the financial sector, banking systems play a critical role in economic development as well as in improving the quality of life of the people of sub-Saharan Africa (SSA). However, little evidence exists in the literature about the performance of the banking systems in SSA compared with developed economies. This paper investigates the effects of economic development on banking performance across 23 SSA countries and 14 developed countries between 1981 and 2018. Using estimation models such as feasible general least squares, fixed-effects estimation with Driscoll-Kraay standard errors, and system and difference generalized method of moments, our findings show that in SSA as a whole, economic development has a positive impact on commercial bank lending, raises lending rates, increases the amount of domestic credit to the private sector (DCPS), and reduces the number of nonperforming loans (NPLs). In developed countries, economic development has a positive impact on lending rates, DCPS, and the number of NPLs. However, although economic development in developed economies has mostly positive effects on banking performance, SSA countries have more performance issues in banking as a whole and in regional pockets. A careful reassessment of SSA’s interregional banking system is therefore highly recommended. An increase in the number of NPLs in East and Southern Africa, a decline in deposit rates offered in Southern, West, and Central Africa, and increasing real interest rates in SSA despite economic growth are some of the concerns that require careful reassessment and policy adjustments.     

Housing slump could cut world growth to decade‐low

• ? A combined slump in house prices and housing investment in the major economies could cut world growth to a 10‐year low of 2.2% by 2020 – and to below 2% if it also triggered a tightening in global credit conditions.
• ? In such a scenario, inflation would remain well below target in the main economies, and US Fed rates would be up to 100 basis points lower than in our baseline by 2021.
• ? Signs of a global house price downturn are already visible, with around a third of our sample of economies seeing falling prices and world residential investment starting to decline. High house price valuations add to the risk that this downturn will deepen in the coming quarters, hitting consumer spending.
• ? Using the Oxford Global Economic Model, we find that a 10% fall in house prices and an 8% fall in housing investment both cut growth by around 0.3%‐0.4% across regions. Adding a sharp Chinese downturn, such as that seen in 2015, has a large additional impact on growth in Asia .

     

Commonality,macroeconomic factors and banking profitability

We study banks’ profitability in the US economy by means of dynamic factor models. Our results emphasize the importance of a few common cyclical market factors that greatly determine banking profitability. We conduct exhaustive regressions in a big data set of macroeconomic variables aiming to gain interpretability of our statistical factors. This allows us to identify three main macroeconomic factors underlying banking profitability: the financial burden of households and economic activity; household income and net worth and, in the case of ROA and ROE, stress in financial markets. We also provide an integrated perspective to analyse banks’ profitability dynamically and to inform policymakers concerned with financial stability issues, for which banks’ profitability is fundamental. Our models allow us to provide several rankings of vulnerable financial institutions considering the common market forces that we estimate. We emphasize the usefulness of such an exercise as a market-monitoring tool.     

Financial development and governance: A panel data analysis incorporating cross-sectional dependence

This study investigates bidirectional causality between governance and financial development using panel data of 101 countries from 1984 to 2013. The financial development–governance nexus is explored using econometric methods robust to cross-sectional dependence, and the relationship between different levels of development and openness is analyzed. Long-run equation estimates show clear evidence that financial development positively affects governance, and this positive impact is found to be robust to three different measures of governance. Further analysis shows that improving governance quality has a positive effect on financial development, while Granger causality tests demonstrate bidirectional causality between financial development and the governance measures. Finally, the impact of financial development on governance is dependent on a country’s level of development and openness. These findings underscore the crucial role of financial development in bringing about good governance reforms and economic growth that, in turn, can further develop the financial sector. As such, a symbiotic and synergistic relationship can persist between good governance, growth, and financial development. The findings provide significant motivation for policymakers to encourage openness and financial sector development to lift the standard of living, especially in emerging economies.     

Transmission of US financial and trade shocks to Asian economies: Implications for spillover of the 2007–2009 US financial crisis

This paper describes an investigation of the transmission of US shocks to Asian economies with consideration of financial linkages and trade linkages. Using the sign restriction vector autoregression (VAR) approach during 2000–2012, our empirical results can be summarized as follows. First, both US financial and trade linkages exert a significant impact on production in Asian economies. Second, through both financial and trade linkages, US spillover shocks account for around 50% of the production fluctuation in Asian economies. Third, during the episodes of 2007–2009 US financial crisis, the impact of financial shocks is greater than that of trade shocks. Results suggest that (i) Asian economies are not decoupled with US; and (ii) different from conventional findings, financial linkages between US and Asian economies are strong, especially for highly developed Asian economies. Therefore, investors and policymakers of Asian economies should take account of US financial conditions.     

Why deflation may be a bigger risk than inflation

• ▀ Concerns about high inflation in the medium term are in our view overdone. In fact, we think the bigger risk is some economies sliding into deflation, due to the coronavirus pandemic's long-lasting negative impact on demand, which will intensify existing global disinflationary trends.
• ▀ We do not think the recent acceleration of monetary growth will lead to rapid inflation, despite the strong historic relationship between the two. The current monetary growth is taking place in extremely unusual circumstances, which may alter the usual link with inflation, and may also be temporary.
• ▀ Meanwhile, most market-based measures of deflation risk have risen recently – in some cases to historic highs. Some household surveys point to slightly higher inflation, but this may reflect short-term volatility in prices for key goods.
• ▀ A slide into deflation would have a variety of negative consequences, including feeding back into private saving, weakening growth, and potentially raising debt sustainability issues in some economies.

     

Alternative policy options for combatting a downturn

• ? With limited scope for conventional monetary policy options, central banks and governments may need to turn to alternative approaches to combat slowing global growth and respond to economic shocks.
• ? Our analysis shows that not only do governments in advanced economies have limited room to cut rates but that doing so has proved less effective in boosting growth in recent years. This increases the need to look at alternatives, such as negative interest rates, renewed QE and fiscal stimulus.
• ? While negative interest rates have helped reduce borrowing costs in some economies, the impact on banks has been ambiguous. Also, lowering rates further into negative territory could be hard without incurring significant costs.
• ? QE in the form practised up to now is also likely to be less effective than in the past due to low yields, narrow risk spreads and high asset valuations. So, a deeper downturn might require more radical QE ‐ buying corporate bonds, bank loans and equities ‐ which comes with significant drawbacks.
• ? Some central bankers are starting to acknowledge the limits of monetary action, with the next step being to consider fiscal action as a more effective alternative ‐ as argued recently by the likes of Larry Summers.
• ? In our view, fiscal policy is likely to be especially effective in a climate of weak growth and low rates, with large multiplier effects. Advanced economies have more scope for fiscal stimulus than often recognised and could finance a large public investment programme by issuing ultra‐cheap long‐dated debt