Pandemic Preparedness: What If?
- Keywords:
- coronavirus
- covid-19
“The interconnectedness of our economies means that literally, no man is an island. If one economy starts to struggle, the spillover effects onto others can take hold rapidly.”—New York Fed President John Williams, November 2019
Human suffering from the outbreak of COVID-19 is clearly much more important than the economic impact of the virus, one of the reasons why we address this topic so reluctantly. The other reason is that there is still such a wide range of potential outcomes for the North American economy—from quite mild to severe—and each so dependent on initial assumptions that any conclusion is necessarily vague. But the accelerating spread of the novel coronavirus to countries outside China—most notably, Korea, Japan, Iran and Italy, and U.S. health officials warning of its imminent spread stateside—has roiled financial markets, and is likely to cause widespread forecast revisions. Prior to this week, consensus growth estimates for the U.S. and Canada had not budged since the start of the year; that seems poised to change. Specifically for Canada, watch for some significant revisions following Friday's 2019Q4 GDP results, which are expected to reveal nearly no growth at the end of last year—even before the virus was an issue.
There have been many attempts in recent years to model the economic impact of pandemics, with studies reaching back to prior episodes such as the severe 1918 Spanish flu, milder outbreaks in 1957 and 1968, the 2002/03 SARS epidemic, and the 2009 H1N1, or swine flu, pandemic. These models must make assumptions on everything from morbidity and mortality rates, to absenteeism among workers, to supply-chain disruptions, to consumer savings patterns, and, of course, to policy responses. Not surprisingly, with such a wide range for inputs, the conclusions are also quite diverse. We looked at 17 different pandemic scenarios (and removed the two extremes), from eight different authors from a variety of countries. Estimates to the economic growth hit ranged from as low as 0.6 percentage points in Year 1, to as high as 6.8 percentage points. (Some studies covered specific economies, while others looked at the global impact.) The median estimate of the models studied is a 1.6 percentage point hit to growth in the domestic economy covered in the first year, with a near complete rebound the following year.
Our own department studied the issue in great detail in 2005/06, when concerns about the avian flu were emerging (“The Avian Flu Crisis: An Economic Update”, March 2006). At that time, Sherry Cooper estimated that the annual loss of real GDP growth would be roughly 2 percentage points in a mild pandemic scenario, and up to 6 percentage points in a severe case, with the hits to Canada and the U.S. of roughly similar magnitudes. In other words, instead of the roughly 2% growth the consensus had been expecting for U.S. growth this year, we would be looking at something close to zero in a mild pandemic scenario and a drop of 4% in a severe case, by these calculations. These estimates skewed somewhat larger than others due, in part, to “the addition of a supply-side disruption in trade and, therefore, significant supply-chain dislocations”.
While that’s a reasonable assumption, some analysts believe the growth hit would be considerably lighter. That same year, Finance Canada estimated that a mild pandemic would cut Canada’s GDP by 0.4 percentage points in a year, while a severe case would clip 1.1 ppts. Authors James and Sargent asserted that spillover effects from shocks are typically overestimated or exaggerated, arguing that “societies are extraordinarily adaptable” and “for almost every direct negative effect there is a potential offsetting response.” They found that monthly data on retail sales and railway car loadings show that the severe 1918 flu had minimal impact on behaviour and activity at that time, despite widespread media coverage. And, looking back at how people responded in the SARS episode, the authors say:
“In the case of SARS, they avoided travelling to the locus of infection. However, what they did not do is as interesting as what they did do. Those who actually lived in Hong Kong, Singapore, Taiwan and Toronto did not “hunker down” or flee in panic. Rather, they carried on with their lives, including working and shopping. They may have been anxious—50% of Taiwan respondents reported wearing a mask during the height of SARS—but they did not become paralyzed with fear, even in the face of intense media coverage.”
In addition, it’s reasonable to assume that the recovery from any growth hit would be V-shaped. Past pandemics have not lasted much beyond a quarter, and typically the economic recovery is swift. For example, while China is no doubt digging a deep hole for growth in Q1, we continue to believe that activity will fully rebound by Q3 (with supply-chain issues delaying the recovery by a quarter). For evidence closer to home, looking at the history of monthly Canadian GDP since the late 1990s clearly displays that even serious shocks tend to be one-month affairs that are typically retraced the very next month (Chart 1). The only sustained drop in output was during the 2008/09 financial crisis, and the current series of events has little in common with that episode.
Finally, there is a very real prospect that policymakers will respond to any serious economic damage- or potentially even the risk thereof-in a meaningful way. While we doubt that monetary policy is a particularly useful tool to combat what is primarily a supply shock, it could mitigate any related weakness in demand—prompted by fear of going out (FOGO) and/or concern about loss of income from an economic slowdown. In that vein, markets are now fully priced for 50 bps of rate cuts this year by both the Fed and the Bank of Canada. Similarly, fiscal policy could play a temporary role in offsetting a drop in demand; some public spending ramp-up may flow in any event from higher health care spending and containment efforts. We were already expecting this year’s Federal Budget to lean into stimulus, with spending and the deficit ramping up, and deepening coronavirus concerns simply reinforce that view.
Bottom Line: The risks to the global economy from COVID-19 have clearly increased with its sudden and rapid spread in major economies outside of China. It is by no means a foregone conclusion that the virus will spread widely in North America. But even in that unfortunate scenario, the economic damage would likely be equivalent to a short, sharp, shock to growth, and activity would likely recover quickly.
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Douglas Porter
Chief Economist and Managing Director
Douglas Porter has over 30 years of experience analyzing global economies and financial markets. As Chief Economist at BMO Financial Group and author of the popular…(..)
View Full Profile >“The interconnectedness of our economies means that literally, no man is an island. If one economy starts to struggle, the spillover effects onto others can take hold rapidly.”—New York Fed President John Williams, November 2019
Human suffering from the outbreak of COVID-19 is clearly much more important than the economic impact of the virus, one of the reasons why we address this topic so reluctantly. The other reason is that there is still such a wide range of potential outcomes for the North American economy—from quite mild to severe—and each so dependent on initial assumptions that any conclusion is necessarily vague. But the accelerating spread of the novel coronavirus to countries outside China—most notably, Korea, Japan, Iran and Italy, and U.S. health officials warning of its imminent spread stateside—has roiled financial markets, and is likely to cause widespread forecast revisions. Prior to this week, consensus growth estimates for the U.S. and Canada had not budged since the start of the year; that seems poised to change. Specifically for Canada, watch for some significant revisions following Friday's 2019Q4 GDP results, which are expected to reveal nearly no growth at the end of last year—even before the virus was an issue.
There have been many attempts in recent years to model the economic impact of pandemics, with studies reaching back to prior episodes such as the severe 1918 Spanish flu, milder outbreaks in 1957 and 1968, the 2002/03 SARS epidemic, and the 2009 H1N1, or swine flu, pandemic. These models must make assumptions on everything from morbidity and mortality rates, to absenteeism among workers, to supply-chain disruptions, to consumer savings patterns, and, of course, to policy responses. Not surprisingly, with such a wide range for inputs, the conclusions are also quite diverse. We looked at 17 different pandemic scenarios (and removed the two extremes), from eight different authors from a variety of countries. Estimates to the economic growth hit ranged from as low as 0.6 percentage points in Year 1, to as high as 6.8 percentage points. (Some studies covered specific economies, while others looked at the global impact.) The median estimate of the models studied is a 1.6 percentage point hit to growth in the domestic economy covered in the first year, with a near complete rebound the following year.
Our own department studied the issue in great detail in 2005/06, when concerns about the avian flu were emerging (“The Avian Flu Crisis: An Economic Update”, March 2006). At that time, Sherry Cooper estimated that the annual loss of real GDP growth would be roughly 2 percentage points in a mild pandemic scenario, and up to 6 percentage points in a severe case, with the hits to Canada and the U.S. of roughly similar magnitudes. In other words, instead of the roughly 2% growth the consensus had been expecting for U.S. growth this year, we would be looking at something close to zero in a mild pandemic scenario and a drop of 4% in a severe case, by these calculations. These estimates skewed somewhat larger than others due, in part, to “the addition of a supply-side disruption in trade and, therefore, significant supply-chain dislocations”.
While that’s a reasonable assumption, some analysts believe the growth hit would be considerably lighter. That same year, Finance Canada estimated that a mild pandemic would cut Canada’s GDP by 0.4 percentage points in a year, while a severe case would clip 1.1 ppts. Authors James and Sargent asserted that spillover effects from shocks are typically overestimated or exaggerated, arguing that “societies are extraordinarily adaptable” and “for almost every direct negative effect there is a potential offsetting response.” They found that monthly data on retail sales and railway car loadings show that the severe 1918 flu had minimal impact on behaviour and activity at that time, despite widespread media coverage. And, looking back at how people responded in the SARS episode, the authors say:
“In the case of SARS, they avoided travelling to the locus of infection. However, what they did not do is as interesting as what they did do. Those who actually lived in Hong Kong, Singapore, Taiwan and Toronto did not “hunker down” or flee in panic. Rather, they carried on with their lives, including working and shopping. They may have been anxious—50% of Taiwan respondents reported wearing a mask during the height of SARS—but they did not become paralyzed with fear, even in the face of intense media coverage.”
In addition, it’s reasonable to assume that the recovery from any growth hit would be V-shaped. Past pandemics have not lasted much beyond a quarter, and typically the economic recovery is swift. For example, while China is no doubt digging a deep hole for growth in Q1, we continue to believe that activity will fully rebound by Q3 (with supply-chain issues delaying the recovery by a quarter). For evidence closer to home, looking at the history of monthly Canadian GDP since the late 1990s clearly displays that even serious shocks tend to be one-month affairs that are typically retraced the very next month (Chart 1). The only sustained drop in output was during the 2008/09 financial crisis, and the current series of events has little in common with that episode.
Finally, there is a very real prospect that policymakers will respond to any serious economic damage- or potentially even the risk thereof-in a meaningful way. While we doubt that monetary policy is a particularly useful tool to combat what is primarily a supply shock, it could mitigate any related weakness in demand—prompted by fear of going out (FOGO) and/or concern about loss of income from an economic slowdown. In that vein, markets are now fully priced for 50 bps of rate cuts this year by both the Fed and the Bank of Canada. Similarly, fiscal policy could play a temporary role in offsetting a drop in demand; some public spending ramp-up may flow in any event from higher health care spending and containment efforts. We were already expecting this year’s Federal Budget to lean into stimulus, with spending and the deficit ramping up, and deepening coronavirus concerns simply reinforce that view.
Bottom Line: The risks to the global economy from COVID-19 have clearly increased with its sudden and rapid spread in major economies outside of China. It is by no means a foregone conclusion that the virus will spread widely in North America. But even in that unfortunate scenario, the economic damage would likely be equivalent to a short, sharp, shock to growth, and activity would likely recover quickly.
View important Disclosure Statements here.
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