The Coronavirus Is A Supply-Side Shock
Summary
- Concern is growing that the spreading coronavirus outbreak will continue to spread and reach a peak later than many people had originally thought.
- As far as the economy goes, policymakers and investors need to understand that the primary economic effect of the virus will be on the supply side of the economy.
- Consequently, monetary and fiscal policies attempting to stimulate aggregate demand will be limited in what they can do and will need to be aimed at protecting on the down side.
- We hope that the final outcome will be less than some are looking for now, but we still need to be prepared for things becoming a lot worse: let's hope that doesn't happen.
Nouriel Roubini, professor of economics at the Stern School of Business at New York University makes it very clear in his opinion piece in the Financial Times that the spreading coronavirus will mainly hit the supply side of the economy, however severe the impact might be.
Mr. Roubini writes “this coronavirus outbreak is mostly a negative supply shock that reduces growth and increases costs and inflation, with some side effects for aggregate demand.”
This is important for policymakers and investors to understand.
Supply-side effects on the economy must be looked at and dealt with in a different way than demand-side problems.
I have argued many times over the past several years that the growth rate of the United States economy, especially in the manufacturing areas, has been as slow as it has been due to the fact that supply-side factors have been such that the economy just cannot grow much faster if it is stimulated by fiscal or monetary programs.
One can point to the fact that the December 2017 tax reform act passed by the US Congress had so little impact on the actual growth rate of the country. Yes, the tax cuts provided some added growth to the total, but when one hears that maybe up to two-thirds of the tax cut went into stock buybacks and even more of the benefits failed to find a way into physical capital expenditures, one can understand why fiscal policies might not be very effective in this era.
Furthermore, as Mr. Roubini notes in his article, “Monetary policy cannot resolve this.” That is, monetary policy cannot overcome slow economic growth created by supply-side factors. This is true in general, but it is also true through supply-side impacts that are created by a health crisis spreading throughout the world.
And, this is just what Mr. Roubini contends is happening.
Oh, there may be some short-term impacts. There was a short-run boost to the economy, but it was relatively small and quickly weakened.
Mr. Roubini suggests that this would be the case for policy efforts, both fiscal and monetary, attempting to fight off the impacts of the coronavirus supply-side impacts. He writes “expect a temporary positive market reaction when central banks signal an accommodative response to the global pandemic. But this reaction will fizzle out when the virus becomes more severe and the economic impact spreads globally.”
As far as the likelihood of this happening, it seems as if more and more people are asking the question of “when” and not “if.” Growing pessimism seems most likely in the coming weeks and possibly months.
Mr. Roubini concludes his piece by stating, “Take all of this together — and the risk of a global recession is rising.
The weapons to fight against this possibility?
I have written a little above about how impotent fiscal policies might be at this time. Given current supply effects of the virus spread and the large amount of uncertainty that exists within the world today, it seems as if aggregate demand stimulus aimed at increasing spending on physical capital investment will not be very effective at all.
Furthermore, efforts to increase aggregate demand these days do not seem very promising. The current economic expansion was started by aggregate demand policies aimed at spurring on consumer spending. It was very successful.
I just don’t see the government being able to ride a supply-side problem to greater growth through further stimulus of consumer spending. I think consumer spending on non-essentials will be severely limited if the virus situation worsens.
In terms of monetary policy, I see little room for the Federal Reserve System to generate much additional activity. As I have written elsewhere, the latest effort can be found here, monetary stimulus is going these days more into the financial circuit of the economy and not into the industrial circuit. Monetary stimulus has problems stimulating the supply side of the economy even in normal times. It will even have more problems in today’s world of credit inflation.
And, of course, the problems mentioned above are not the only problems in the world. Mr. Roubini goes on, “The coronavirus outbreak is likely to be only one of many negative shocks that will hit the global economy this year. Others include the risk of a war between the US and Iran causing a spike in oil prices; political chaos in the US as foreign rivals interfere in the upcoming election; and an escalation in tension between the US and China.”
The Federal Reserve has been projecting the United States economy would only be growing at a 2.0 percent rate this year.
More and more, it is looking like a 2.0 percent growth rate might be on the high side of the projections for this year.
And, what a difficult time this will mean for Fed Chair Jerome Powell and the Federal Reserve. Mr. Powell has been talking about the spread of the virus for a month or more now and indicating that the Fed is ready to respond to greater difficulties.
I will assume that the Fed will respond appropriately to any economic and financial difficulties arising from the health situation, but the greatest effect of appropriate Federal Reserve actions will be protecting the economy from a downward spiral. As mentioned above, I see little in the way of what they can do on the upside.
Fiscal policy doesn’t really have many tools left to deal with supply-side problems. The best it may be able to do is to support as well as possible those that need to be supported due to any outbreak that may occur. It may not be able to do much more than that.
Of course, let’s hope that things don’t get much worse than they are now. But we need to be prepared. This situation is real. The situation is one of supply-side disruptions. There is only so much that can be done to combat these kinds of disturbances. Policymakers and investors need to stay alert and be prepared.
I still remain an optimist, but this does not mean I shouldn’t be aware of other possibilities. I am not overreacting now. But I stand ready to move, should the need arise.
This article was written by
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Comments (10)
Airlines, Cruise liners, Energy, Luxury goods, casinos, gaming, transportation , clothing retailers, real estate & construction, hotels are directly impacted by demand side contraction. Commodities, Auto parts, Banks, Oil, etc. are impacted by supply side disruption in China & Far East... hope this horror show ends soon....
In the short run, an economy-wide negative supply shock will shift the aggregate supply curve leftward, decreasing the output and increasing the price level." -- WikipediaSumner: "Increased probability that monetary policymakers will not be aggressive enough to prevent a recession, and if the recession occurs then demand will still be rather sluggish in January 2023 because the Fed will be too hawkish in the recovery...In other words, we need adequate NGDP in 2023, and if we don’t get it then it will be the Fed’s fault."Scott Sumner is exactly right.Dr. Nouriel Roubini is nearly correct.“If its output shrinks just 2 per cent in the first quarter, that is an annualised contraction of 8 per cent. A V-shaped rebound would therefore require the same annualised growth, which exceeds the 6 per cent that China managed before the virus”There becomes an elongated “sweet spot” in monetary flows, volume times transaction’s velocity , where inflation is interrupted for an increased period of time. The Fed should take this opportunity to ease its money policy. It should lower the remuneration rate on interbank demand deposits.
