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Expecting a quick economic recovery? Don’t hold your breath

Apr 13 2020

The COVID-19 pandemic is posing a monumental challenge for economic forecasters. How can they look ahead with any certainty as events without modern precedent unfold at lightning speeds?

So far, they can’t — which is why predictions of U.S. GDP growth are wildly inconsistent these days. Part of the problem is that classic forecasts not only rely heavily on historic trends, but also take time to determine. This crisis allows for neither.

“The challenge for economists and policymakers in the COVID-19 crisis is that comparisons to prior events are hard, whether it’s to the 2008-2009 global recession, or 9/11 or the Great Depression,” says Nicholas Bloom, a Stanford economist and senior fellow at the Stanford Institute for Economic Policy Research (SIEPR). “Also, everything is happening now in dog years. Two weeks is like six months of normal time.”

In response, Bloom and a team of researchers have come up with a responsive model for forecasting that can set reasonable expectations for what’s to come. Their approach, published today as a working paper by the National Bureau of Economic Research, combines the most up-to-date, forward-looking data available with analyses of the economic shocks that followed natural disasters, political coups, revolutions, and terrorist attacks in more than three dozen countries over two decades.

Their prognosis is grim.

While some economists are predicting either a “V-shaped” or “U-shaped” downturn and recovery in the United States, Bloom and his collaborators say the impact will look more like an “L.”

After year-over-year declines that could plummet to 20 percent by the fourth quarter of this year, the U.S. economy will hobble along through 2021 before reaching positive growth in the second quarter of 2022.

Bloom says the short- and long-term outlook could be even worse given factors his team did not consider, among them anti-trade and anti-immigrant sentiments, inevitably higher taxes, severe cuts by businesses in research and development, and steep drops in employee productivity due to working from home.

“I’m very pessimistic,” says Bloom, who is a professor in the Department of Economics and also a professor, by courtesy, in the Stanford Graduate School of Business.

He expects GDP to fall 15 percent in the current quarter compared to the first three months of 2020 and continue to fall — by another 15 percent and then 10 percent — in the last two quarters of the year.

His own prediction? The U.S. economy won’t fully recover to its pre-crisis state until 2025, though he says it could happen a year sooner.

‘Unlike anything we’ve ever seen’

For Bloom and his collaborators — former Stanford PhD students Scott Baker and Stephen J. Terry, now at Northwestern University and Boston University, respectively; and, Steven J. Davis of The University of Chicago Booth School of Business — the onset of COVID-19 was serendipitous.

The scholars were putting the finishing touches on a working paper that looked at the effects of sudden shocks to the economies of 38 countries between 1987 and 2017. As the U.S. stock market dove in late February, Bloom was in Mexico to give a keynote speech about the study — which was seven years in the making due to the complexity of the data — at the country’s top-ranked ITAM Business School.

Bloom recalls conference attendees at the time debating whether a recession would follow (he said one would). But in a sign of just how quickly the COVID-19 pandemic has altered calculations, a week later discussions had turned to the prospects of a 2008-2009 global recession. Soon, there was talk of another Great Depression. With the stock market down 28 percent and 10 million people out of work by the end of March, “Greater Depression” had entered the vernacular.

Bloom and his team turned their attention to adapting their “empirical model of disaster effects” to estimate the short- and near-term effects of the COVID-19 crisis. They did so by combining their empirical model with forward-looking, real-time data in their closely-watched Economic Policy Uncertainty Index. The index comprises three measures: newspaper coverage of economic uncertainty, federal tax provisions due to expire, and disagreement among forecasters. It is now at an all-time high.

Using this approach, the scholars calculated two COVID-19 impacts. One is called the “first moment” shock — this would be the immediate drop in demand and supply due to the pandemic.

The second metric has to do with the uncertainty triggered by the crisis. The uncertainty occurs when companies stop hiring or investing in research and development because they are worried about their future financial health. Fear causes consumers to stop buying homes and cars and making other big purchases. A new World Uncertainty Index that Bloom and his colleagues released in early April just how skittish the outlook is.

Using this “empirical model of disaster effects” and data on U.S.  GDP, Bloom and his team predict in their paper that the country’s economy could contract 9 percent in the current quarter (or 36 percent on an annualized basis). That’s as much as 20 percent during the last three months of this year.

The economy won’t return to growth mode until after the first quarter of 2021. Sixty percent of that reversal, the authors write, will come from uncertainty created by COVID-19.

“These are enormous drops in GDP and unlike anything we’ve ever seen,” says Bloom, who likens the crisis to the Sept. 11, 2001 terrorist attacks and the Dec. 7, 1941 bombing of Pearl Harbor. “I can’t think of any other events in American history that have been this extreme.”

And there is, of course, the specter of the 1929 stock market crash that sparked the decade-long Great Depression. President Herbert Hoover has been blamed for not acting fast enough to address the crisis in the early years. But part of the problem was he didn’t have data showing the depths of the economic fallout, which slowed government response.

“Hoover was flying blind,” says Bloom. “We don’t want to repeat that, which is why it’s so important to have forward-looking measures available now to policymakers.”

Krysten Crawford is a freelance writer.

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