Epidemiologists are nervously tracking signs that the novel coronavirus is spreading widely beyond its origins in China. Economists are watching for much the same thing when it comes to the economic damage.
The global outbreak has caused upheaval in stock markets and disrupted supply chains around the world. On Tuesday, the Federal Reserve took aggressive steps to try to contain the damage, announcing that it would slash interest rates by half a percentage point.
So far, there have been few signs of widespread economic damage, at least in the United States. Most employers aren’t laying off workers. Consumers are still spending. Shops and restaurants remain open. The Fed’s move is an effort to keep it that way.
Economists say a pandemic could clearly cause a recession in the United States. But for that to happen, the effects would have to spread beyond manufacturing, travel and other sectors directly affected by the disease. The real sign of trouble, said Tara Sinclair, an economist at George Washington University, will be when companies with no direct connection to the virus start reporting a slump in business.
“The key is to watch big macro numbers rather than obsessively watching things tied to virus and supply chains,” Sinclair said. “If people aren’t getting haircuts anymore, that’s a bad sign.”
The coronavirus epidemic is evolving rapidly, and no one can predict the economic impact with any confidence. Instead, analysts tend to think in terms of scenarios — what are the different ways the situation could play out? And what are the risks that existed even before the virus struck?
The coronavirus will damage the economy.
The outbreak has already caused factories to be closed, flights grounded and events canceled. Entire cities in Asia and Europe are nearly shut down. Apple, Mastercard, United Airlines and dozens of other companies have warned that the virus will hurt profits.
The Organization for Economic Cooperation and Development said Monday that global growth could be cut in half, to 1.5% in 2020, if the virus continues to spread. Laurence Boone, the group’s chief economist, warned that the forecast was “not a worst-case scenario.”
The United States will not be immune. Goldman Sachs estimated over the weekend that the outbreak would reduce economic growth by a full percentage point in 2020.
The economy was growing at an annual rate of only around 2% before the virus hit. So if the outbreak worsens, it isn’t hard to imagine that gross domestic product might fall outright.
But a recession is more than just a dip in gross domestic product. As most economists think of it, a recession involves a cycle that feeds on itself: Job cuts lead to less income, which leads to less spending, which leads to more job cuts. (Of course, that doesn’t go on indefinitely, especially if central banks and governments intervene forcefully to kick-start growth.)
“Consumer spending being 70% of the economy, you are going to have to see it on the consumer side for this to take the U.S. economy down,” said Claudia Sahm, a former Fed official who is now director of macroeconomic policy for the Center for Equitable Growth, a progressive think tank. She noted that some researchers had studied how shocks spread through the economy, using methods originally developed to model the spread of disease.
Think about hurricanes or earthquakes. A bad natural disaster can easily cause output to decline in one part of the country, as stores close, shipments are delayed and people stay in their homes or shelters. A really bad one might even cause a dip in GDP.
But barring other factors, the economy should snap back once the water recedes or the ground stops shaking. In fact, natural disasters are often followed by a temporary increase in economic activity, as people rebuild. In that way, disasters are different from financial crises, for example, which don’t just reduce spending and investment in the short term but also make people and companies less willing or able to spend for months or years.
So far, the coronavirus outbreak looks more like a hurricane than like a financial crisis — but that could change quickly.
The economic contagion could spread.
Here’s how a coronavirus could cause a recession: As fear of the virus spreads, Americans stop going to restaurants, concerts and the movies. Airlines cancel domestic flights. Sports leagues scrap games. Hotels, museums and amusement parks close.
Then, with less revenue and no certainty on when business will bounce back, companies start laying off employees. Newly unemployed workers pull back spending further, and others, fearful that their jobs could be next, do the same. That hurts demand for an even wider array of products, forcing more layoffs and pushing some companies into bankruptcy.
Or imagine a slight twist: Supply-chain disruptions make it hard for manufacturers to get parts, and for retailers to stock shelves. With nothing to sell, they have to lay off workers, setting off the same cycle of job losses and reduced spending.
The common element in both cases: Once the direct effects of the coronavirus spread to the job market, the ripples reach much further into the economy. If that happens, the economy might remain sluggish even after the outbreak is controlled.
“The question is whether it pushes firms so far that they go out of business or start laying employees off,” said Karen Dynan, a Harvard economist and former official in the Treasury Department. “That’s where you can get the bigger impacts on the economy.”
Numbers will begin to tell the story.
The impact of the coronavirus won’t show up in economic statistics right away. Hardly any data is available from February, when the virus began to spread widely beyond China, and its effect on jobs and spending might not be clear until the spring or summer.
The few indicators that are available so far paint a mixed picture. In the University of Michigan’s survey of consumer sentiment, 20% of respondents interviewed last week cited the coronavirus as a concern, and even they were relatively confident about the economy on average. Recent surveys from the Federal Reserve Bank of Kansas City and the Institute for Supply Management similarly found that companies were nervous about the virus but that business activity was still increasing.
Such sentiment indicators could be among the first to detect trouble. Economists will also be watching weekly claims for unemployment insurance to see if layoffs are picking up and monthly retail sales data for signs that consumers are deferring restaurant meals or other spending. Measures of financial conditions, such as an index from the Federal Reserve Bank of Chicago, should signal whether financial institutions become reluctant to lend, another way the outbreak could slow the broader economy.
One indicator that economists do not recommend focusing on is the stock market. Yes, stocks just had their worst week since the 2008 financial crisis. And yes, the evaporation (at least on paper) of some $6 trillion in wealth could cause some people to reconsider buying new cars or splurging on vacations, a phenomenon economists call the “wealth effect.”
But the stock market is dominated by multinational corporations. Its drop — at least before a resurgence on Monday — reflected fears of what a pandemic could mean for Asia and Europe as well as the United States. And the wealth effect, though real, isn’t that big — most Americans don’t own stocks outside of retirement accounts, so the effects of a short-term drop are limited.
The economy has a cushion (but not a big one).
Before the coronavirus spread, hardly any forecasters expected a recession in 2020. The unemployment rate is near a 50-year low. Inflation is tame. The housing market has been gaining strength, and job growth has been steady.
That underlying momentum could help prevent a recession. Businesses that have been struggling to find enough workers may be reluctant to lay them off at the first sign of trouble. Households have relatively little debt, giving them a buffer during a slowdown.
But many companies have heavy debt loads, which could make it harder for them to weather any virus-induced slowdown. Business investment was already falling, and President Donald Trump’s trade war has taken a toll on the manufacturing sector. Most economists already expected growth to slow enough this year to leave the economy vulnerable.
“A lot of forecasters have been saying, ‘If we were to see a recession in the next year or two, it would be coming from some external shock,’ and indeed that’s just what we’re getting,” Dynan said.
Most economists still expect the United States to escape a recession, although other countries probably won’t be so lucky. And they say a coronavirus-caused recession would probably be relatively minor. But that might not be much comfort — economists are notoriously bad at predicting recessions.