OECD Economic Outlook, Volume 2020 Issue 1

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OECD Economic Outlook

10 June 2020

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1. General assessment of the macroeconomic situation

Introduction

The COVID-19 pandemic is a global public health crisis without precedent in living memory, and continues to result in a widespread loss of life and severe human suffering. To contain the spread of the virus and save lives, most governments throughout the world imposed stringent containment measures. Activity in many sectors was shut down completely and travel and mobility curtailed. These necessary measures have succeeded in slowing the spread of infections and reducing the death toll, but have resulted in large short-term economic disruption and job losses, compounded by falling confidence and tighter financial conditions. The global economy is now experiencing the deepest recession since the Great Depression in the 1930s, with GDP declines of more than 20% in many countries during shutdowns and a surge in unemployment.

The economic outlook is exceptionally uncertain. With the easing of the health emergency, confinement measures are being scaled back gradually. The restarting of activities automatically adds to output, even though some containment measures, such as the closure of many international borders, will remain for some time. The recovery is likely to be hesitant, and could be interrupted by another coronavirus outbreak if targeted containment measures, notably test, track and trace (TTT) programmes, are not put in place or prove ineffective. Reflecting the unusual degree of uncertainty, this Economic Outlook presents two equally likely scenarios for each country and economy – one scenario in which a second outbreak occurs in all economies towards the end of this year (Table 1.1, Panel A) and an alternative scenario where the second outbreak is avoided (Table 1.1, Panel B). In the “double-hit” scenario, global GDP is projected to decline by 7.6% this year and remain well short of its pre‑crisis level at the end of 2021; in the “single-hit” scenario, world GDP is projected to decline by 6% this year, but will have almost regained the pre-crisis level at the end of 2021. Even so, in many advanced economies, the equivalent of five years or more of per capita real income growth could be lost by 2021.

Governments and monetary authorities reacted remarkably quickly to the crisis, reducing the spread of the virus and preventing an even larger economic and financial collapse. Emergency measures expanded hospital and other healthcare capacities, helped to preserve the incomes of workers and companies despite the shutdown, and guaranteed private debt on a large scale in some countries. Monetary policy has been eased, with interest rates cut, enhanced asset purchase programmes and targeted interventions in financial market segments under extreme stress. Financial policy has also been relaxed to support credit provision by financial institutions. As a result, policymakers now face exceptional challenges: government budget deficits are elevated and public debt is set to rise to exceptionally high levels in many countries, interest rates have been reduced to zero or below, and central bank balance sheets have expanded dramatically.

Table 1.1. Global activity has collapsed and the recovery will be slow and possibly interrupted

Given the exceptional level of uncertainty, flexible and agile policies are needed to cope with possible renewed virus outbreaks, exit strategies that differ across sectors, and the challenges that will be left by the deep collapse in output. Should another virus outbreak occur, as assumed in the double-hit scenario, or the recovery prove unexpectedly weak, it will fall to fiscal policy to provide additional stimulus given the limited scope for further monetary policy easing. However, in this case it might be necessary for the monetary authorities to boost programmes to support liquidity and lending and ensure interest rates remain low along the yield curve.

Even if another outbreak of the pandemic does not occur, supportive fiscal and monetary policy stances should be maintained in order to foster a durable recovery, with some industries likely to experience lower levels of activity for some time. The deterioration in the public finances in the current year will be offset to some extent in 2021 by a cyclical budget improvement and the scaling down of emergency measures, but budget deficits and debts will remain much higher than in 2019. Given the likely fragility of the recovery, and subdued inflation, care should be taken not to withdraw emergency measures too quickly or, if such measures are terminated, to substitute them with others that provide stronger stimulus to the economy. Monetary policy should remain very accommodative and ensure that interest rates remain low to prevent the crowding out of private spending.

The crisis will cast a long shadow over the world and OECD economies. By 2021, it will have taken real income per capita in the majority of OECD economies back to 2013 levels in the double-hit scenario and to 2016 levels in the single-hit scenario. It may permanently reduce potential output due to the premature scrapping of capital that is likely to accompany higher bankruptcies, and hysteresis in labour markets as unemployment spells lengthen. A renewed effort to implement reforms that strengthen productivity and employment growth in an inclusive way, and foster the reallocation of resources across sectors, is needed to counter these negative crisis-related shocks. Likewise, the temporary disruption to global value chains during the crisis could prompt businesses to enhance resilience by permanently diminishing their supply chains and reducing inputs from efficient but distant providers, thereby harming global efficiency and income.

Stronger international co-operation is needed to help end the pandemic more quickly, speed up the global economic recovery, and avoid harming the catch-up process of emerging-market economies and developing countries. The sharing of knowledge, medical and financial resources, and reducing harmful bans to trade, especially in healthcare products, are essential to address the challenges brought by the pandemic.

Global activity has collapsed suddenly

The pandemic and the necessary containment measures used to limit its spread have closed down large segments of economies around the world this year, triggering sharp and sudden contractions in output, spending and employment. Global GDP is estimated to have declined by around 3% in the first quarter of 2020, even though containment and mitigation measures were introduced only during the course of March in many countries (Figure 1.1). Activity declined sharply in China, the initial centre of the pandemic, with the level of output 10% below that in the fourth quarter of 2019. Other economies in Asia with strong links to China through supply chains and tourist flows also experienced output contractions. Amongst the other major advanced economies, output declined more sharply in the euro area than in the United States and Japan, reflecting the earlier and more stringent shutdown measures implemented in many European economies and weak underlying growth momentum prior to the shutdowns.

Figure 1.1. Global activity declined abruptly in the first quarter of 2020

Percentage change in GDP, quarter-on-quarter

The full impact of the shutdowns has resulted in an even larger global output decline in the second quarter of 2020. Unexpected supply-side shocks have disrupted many businesses, with the closure of non‑essential activities and restrictions on travel creating difficulties in operating effectively and impairing relationships with key suppliers. Demand also weakened abruptly, particularly for many consumer goods and services in which there is close contact between producers and consumers, and for travel and tourism activities. This has caused large revenue losses and a severe liquidity shock for many companies (see below). Sharp declines in consumer confidence and rising unemployment, are restricting household consumption and adding to precautionary saving. Small and medium-sized enterprises (SMEs) have been particularly affected, with many operating in the service sectors most directly impacted by shutdowns, and having limited financial buffers to cushion sharp drops in turnover (OECD, 2020a).

Illustrative OECD benchmark estimates in March suggested that around one-quarter of the economy could be shut down directly in many countries following the implementation of stringent containment measures to mitigate the pandemic, with consumers’ expenditure potentially cut back by around one-third (OECD, 2020b). Available estimates in other countries point to broadly comparable declines in some, but smaller effects in those countries adopting less stringent containment measures (Chapter 2, Issue Note 1). In all countries, activity declines have been relatively concentrated in a handful of job-intensive sectors, particularly retail and wholesale trade, accommodation and food services. Linkages with suppliers, and the constraints on labour availability in sectors where teleworking is limited, have added to the disruption in other parts of the economy (OECD, 2020b), particularly in manufacturing industries. Weaker confidence, and disruptions to cross-border supply chains, have further raised these effects.

Early data have already made clear that the economic and social costs of the pandemic are large. Business survey indicators plummeted to record lows in most countries in April, with the declines particularly marked in service sectors, in contrast to the pattern normally seen during recessions (Figure 1.2). Despite some mild recovery in May, as countries began to exit slowly from confinement, most indicators remained at low levels. Many service sectors continue to be impacted significantly by distancing measures, the closure of non‑essential businesses, and restrictions on mobility.

Figure 1.2. Survey measures of business activity remain exceptionally weak

High-frequency indicators illustrate the extent to which some activities have now begun to restart following the gradual introduction of exit measures in many countries, but also continue to highlight important differences across countries (Figure 1.3). Daily measures of mobility, travel and workplace attendance plummeted in March and April, electricity consumption declined markedly and many leisure and tourist activities virtually ceased. Such changes were particularly marked in many large European countries and emerging‑market economies, such as India, South Africa and Argentina, with relatively strict and tightly enforced containment measures. Smaller declines occurred in some Asian economies where greater use has been made of effective TTT procedures to contain the virus outbreak rather than full shutdowns, and in the United States. The ongoing recovery in China following the relaxation of containment measures in February, particularly in manufacturing sectors, has also helped to limit the decline in overall global activity to some extent. Data for May suggest that the full impact of containment measures has begun to ease gradually in most economies, though Japan where shutdown measures began relatively late, is an exception (Figure 1.3, Panels A and B). Activity in some sectors, such as air travel, also remains very weak.

Spending on some consumer durable goods, such as cars, has fallen exceptionally sharply. Global car sales in March and April were 37% lower than the monthly average in 2019, with a gradual recovery of demand in China offset by weakness elsewhere. Sales of new vehicles came to a virtual halt in April in many countries, including Spain, Italy, the United Kingdom and South Africa. Sales in the euro area and the United States in April were around one‑fifth and one-half respectively of the level in 2019. High uncertainty and the collapse in demand for many businesses have further weakened the outlook for investment. Production of capital goods in the major advanced economies declined by around 12% in the first quarter of 2020, after having already fallen in the latter half of 2019, and survey measures of investment intentions have dropped sharply.

Figure 1.3. High-frequency data point to sharp contractions in activity during shutdowns

Labour market conditions have deteriorated considerably, with unemployment claims and applications for short-time work schemes soaring, reflecting job losses and reduced work hours. In the United States, an unprecedented shock has occurred in the labour market. The number of people in non-farm payroll employment in May was over 13% lower than in February, undoing to all of the job growth achieved over the past decade. The unemployment rate has also soared, averaging 14% in April and May, the highest since the Great Depression, with a broad measure of unemployment plus the under-employed (U6) now over 20%. Extensive government‑funded schemes have helped to limit the rise in unemployment in the large European economies, particularly for workers with permanent contracts, with around 20‑25% of the private sector workforce being supported by short‑time work or wage support schemes in the major European economies. Labour market changes have so far been less marked in Japan, reflecting differences in the timing and extent of shutdowns, but the unemployment rate has edged up and consumers’ assessment of labour market conditions fell to a record low in April and May. A rise in teleworking since the start of the crisis has cushioned working hours in many countries, but survey evidence suggests that under one‑half of workers are able to telework regularly (ONS, 2020; Statistics Canada, 2020).

World trade is also now contracting sharply, with the volume of goods and services estimated to have fallen by 3¾ per cent in the first three months of 2020 (Figure 1.4). Air traffic has been particularly hard hit, with international passenger traffic in April over 98% lower than a year earlier, and international freight traffic in April close to 30% below the level a year earlier. Disruptions to suppliers due to containment measures and the virtual cessation of international travel have added to the effects of the collapse in demand. Global export orders fell to their lowest level on record in April and remained exceptionally weak in May, with all countries reporting sizeable declines. These declines have been especially deep in Europe and some emerging-market economies, particularly India and Indonesia. Even in countries where containment measures have been relatively light, many businesses are being impacted severely by a sharp fall in external demand.

Figure 1.4. World trade is now collapsing

Risk aversion in financial markets rose substantially at the beginning of the COVID-19 outbreak but has eased recently. The rapid spread of the pandemic and the strict containment measures adopted by governments prompted massive declines in financial asset prices and a spike in volatility, with some markets ceasing to function properly. In many countries, equity prices collapsed by 30-50% and at the fastest daily pace since 1987, and equity price volatility soared above the levels in the global financial crisis (Figure 1.5, Panels A and C). Long-term government bond yields have declined substantially in many advanced economies, reflecting monetary policy easing and a flight to safety, but spreads have risen on many emerging‑market government bonds, amidst record high capital outflows and a substantial appreciation of the US dollar (see below). Corporate bond spreads have also risen, particularly for the lowest rated borrowers, with rising risks of downgrades due to the recession and pre-crisis vulnerabilities related to the high level of indebtedness and deteriorated credit quality (see below). Spreads also increased for investment-grade corporate bonds with lower default risks, given strong demand for cash by investors and their readiness to raise cash by selling such liquid instruments (Haddad et al., 2020). Rapid and sweeping responses by central banks, including through the activation of international liquidity lines (see below), have helped to restore some stability, with a partial reversal in financial asset price moves and lower volatility. Still, in many large economies, equity prices are 10‑20% below the end‑2019 levels, and volatility and spread measures somewhat higher than six months ago (Figure 1.5, Panel C).

Figure 1.5. Financial market tensions have increased

The evolution of the COVID-19 pandemic and exit strategies is uncertain

The COVID-19 outbreak is the most serious global health crisis since the Spanish flu pandemic just over a century ago. Since the outbreak started in China in December 2019, it has spread across the world, with most countries affected. In early June, confirmed cases globally had reached more than 6½ million and around 380 thousand deaths had been registered. While global infection and fatality rates are so far well below those estimated for the Spanish flu pandemic,1 both are likely to be under‑recorded to a varying extent across countries and measured in different ways. Confirmed cases are likely to be only a fraction of all cases because of low testing intensity among the general public and the prevalence of asymptomatic cases that go undetected. Recorded death rates are also subject to important measurement problems.2 Under-reporting is likely to be particularly acute in some emerging-market economies and developing countries, reflecting low capacity in their healthcare sectors and different policy choices to deal with the pandemic. Lack of comprehensive and standardised high‑quality data that would allow the epidemiological characteristics of the COVID-19 virus to be better understood makes the outlook for the pandemic uncertain (Box 1.1).

Box 1.1. The epidemiological outlook is uncertain

Incomplete data and insufficient knowledge about the nature of the new virus make it uncertain how the pandemic will evolve:

The COVID-19 virus is highly infectious, but the extent of its infectiousness is uncertain. The consensus is that the reproduction rate (i.e. how many susceptible people each person with the pathogen infects, R0) is between 2 and 3 in the absence of containment measures, but higher numbers are also reported (Katul et al., 2020). In the absence of measures to control the outbreak by suppressing contact rates – the non-biological factor of the reproduction rate – such high numbers would imply high eventual population infection rates. If reporting is accurate, the low incidence of accumulated confirmed cases suggests that lockdowns and other restraining measures have succeeded in reducing the effective reproduction rate to below unity, in which case infections could rise sharply again when such measures are relaxed. However, if there is widespread under-reporting, the lifting of restrictions would be accompanied by a smaller increase in infection rates.
Indeed, the true extent of the infection of the population, and how close it is to the levels needed for herd immunity, is controversial. Evidence from countries with high testing intensity (e.g. Iceland and Luxembourg) and recent national studies (e.g. France and the Czech Republic) indicate that only around 6% of the national population has been infected. This is well below the level required for herd immunity given the likely basic reproduction rate for the virus. And the degree and duration of immunity obtained through infection, the premise for herd immunity, is still uncertain.
Early estimates of the case fatality rate ranged from 0.4% to 3.8% (WHO, 2020), and have tended to rise with time as infections have spread globally. The wide range of estimates are suggestive of the importance of other biological factors, such as chronic diseases, and possible non-biological factors, such as healthcare capacity, in determining mortality rates from the virus.
The possible seasonality of the virus is yet to be confirmed. To the extent that hot temperatures and wetness weaken the virus, infections should diminish in the Northern Hemisphere in the coming months, but the reverse would be the case for the Southern Hemisphere. But seasonality would also imply that a new outbreak emerges in the Northern Hemisphere later in the year.
The timing of a discovery of vaccine is inherently uncertain, and hence the time when the virus is no longer a threat to human life. It can take six to seven years to develop and mass‑produce new vaccine. However, a vaccine for COVID-19 could be developed in 12 to 18 months, given the extraordinary global efforts that the scientific community and pharmaceutical companies are making towards this end. Even so, it remains to be seen how quickly a vaccine can be found and distributed to the general population.

Healthcare capacity is being increased

The capacity of the healthcare sector to deal with COVID-19 infections will have an important bearing on the future course of government measures to contain the pandemic. Indeed, the measures put in place in recent months in many countries were designed to reduce the peak of the outbreak to levels that healthcare facilities, including intensive care units (ICUs) in the hospital sector, could cope with. There is little cross‑country comparative data available on ICU beds.3 Non-standardised data suggest that some countries (including Germany and the United States) entered the outbreak with significantly higher capacity than others (OECD, 2020c). However, the hard‑hit countries in Europe (France, Italy, Spain and the United Kingdom) have all been able to expand their ICU capacity significantly, and are better placed than before to cope with a new outbreak. In many emerging-market economies and developing countries, ICU capacity is very limited or negligible. As discussed below, enhanced testing capacity and the availability of personal protective equipment (PPE) are required to allow added flexibility in the choice of future containment policies.

The exit from lockdown and containment measures

The exit from lockdown and other containment measures is now underway and exit strategies have been announced in several countries. This has been prompted by signs that new infection and death rates are stabilising or declining, and the perceived economic need to restart economic activity and social life. In many countries, the strategies are gradual, with movement from one stage to another being conditional on epidemiological and healthcare capacity criteria being met.

The scaling down of shutdown and confinement measures is accompanied by strict requirements on PPE in most countries, including the obligatory wearing of masks in some public places and employers’ provision of such equipment. Personal interactions are also limited, such as ceilings on the number of customers in stores at any time, requirements that distance rules be observed and reductions in school class sizes. These raise the cost of doing business and limit the speed of the recovery, as many businesses will only be able to reopen with significantly reduced capacity. Also, some measures, notably limits on people crossing national borders, look set to remain in force at least partially for a protracted period, with an adverse impact on international tourism and operations of multinational companies. Voluntary physical distancing and companies’ concerns over potential liabilities from employees becoming infected in the workplace may further damp the recovery.

An essential part of a successful exit strategy is to develop large‑scale effective TTT programmes (OECD, 2020d). As long as no vaccine is available and shutdown restrictions are eased, it will be crucial to suppress local outbreaks quickly before they spread more widely. This requires testing more people to identify who is infected; tracking and isolating them to make sure they do not spread the disease further; and tracing others they have been in contact with. In addition, intensive testing can identify people who have developed immunity and can safely return to work; and provide more solid information about the evolution of the pandemic.

In event of a further general virus outbreak later in the year, large‑scale TTT programmes would allow governments to apply more targeted measures than in the first outbreak. Increased hospital capacity, due to both expansion of ICU beds and the experience gained by healthcare workers, and increased availability of PPE may also lessen the need to apply very restrictive nationwide shutdowns and other strict containment measures. Even so, another intensive outbreak would be very likely to result in renewed containment measures, albeit smaller in scope.

Two epidemiological scenarios

Given the uncertainties listed above, two possible epidemiological scenarios can be considered for the coming 18 months.

A double-hit scenario: The current easing of containment measures is assumed to be followed by a second, but less intensive, virus outbreak taking place in October/November. This could be because of seasonal factors in some countries, particularly in the Northern Hemisphere, or because containment, test, tracing and isolating is not as efficient as expected. It could also reflect insufficiently high cumulative infection rates to generate adequate herd immunity, a lack of suitable treatment measures and the unavailability of a vaccine. Further outbreaks in 2021 are assumed to be avoided due to pharmaceutical breakthroughs, but these remain a significant downside risk.
A single-hit scenario: The current containment measures are assumed to successfully overcome the current outbreak, with the effective reproduction rate declining and staying persistently below unity. Higher hospital capacity and the widespread roll-out of effective testing, tracking and treating are assumed to be sufficient to prevent a resurgence in infections and intensive cases later in the year and until a vaccine becomes available.

Short-term outlook scenarios for an uncertain global economy

The current conjuncture and the outlook are exceptionally uncertain. Growth prospects depend on many factors, including the magnitude and duration of national shutdowns, the pace at which containment measures are eased, the impact on confidence, and the speed at which the significant fiscal and monetary policy support put in place by governments and monetary authorities takes effect. The unwinding of restrictive measures has begun in most countries, but the strategies adopted differ across countries, regions and sectors. Restrictions on some activities, such as international travel and spectator sports, are likely to persist for some time in many economies. Considerable uncertainty is also likely to prevail for an extended period, holding back investment, even if a fresh wave of the pandemic can be avoided. Many businesses in the service sectors most affected by shutdowns are likely to be insolvent if sufficient capacity cannot be restored and demand does not recover, with attendant job losses. Rising unemployment is also likely to push up precautionary saving by households, and for millions of informal workers the crisis worsens the risk of poverty and deprivation. In a world strongly interconnected through supply chains, international tourism flows and investment, all economies are affected significantly by the disruptions to demand and supply, irrespective of the strength of the national measures taken to contain the impact of the pandemic. Pre-existing vulnerabilities, such as high corporate debt and its declining quality, and trade tensions between major economies, could also deepen the downturn and slow any subsequent recovery.

Given this uncertainty, two conditional scenarios have been developed to reflect the possible evolution of the global economy. The difference between the two scenarios is that the double-hit scenario is conditioned on an assumption that renewed shutdowns are implemented in all economies in the fourth quarter of 2020, following a further marked global outbreak of the COVID-19 virus. These shutdowns are assumed to be around one-half of those already implemented in the first half of the year, and be eased at different rates across sectors after 2-3 months.

The current deep recession will be followed by a slow recovery

All countries are projected to experience a deep recession in 2020 followed by a slow and gradual recovery in 2021 in both scenarios. In the double-hit scenario, global GDP is projected to decline by just under 7¾ per cent in 2020, before rising by around 2¾ per cent in 2021 (Figure 1.6, Panel A). Output declines are even stronger in the OECD economies, with OECD GDP projected to drop by 9¼ per cent in 2020 (Figure 1.6, Panel B). Under the single-hit scenario, there is still a very large drop in output this year, with projected declines in global GDP and OECD GDP of 6% and 7½ per cent respectively in 2020. However, growth prospects are somewhat stronger in 2021, helped by strong carryover effects from a gradual resumption of activity during the latter half of 2020, with global GDP projected to rise by around 5¼ per cent next year.

At its peak, in the second quarter of 2020, an unprecedented decline in activity is estimated to have occurred (Figure 1.7), with the level of world output around 12½ per cent lower than in the fourth quarter of 2019, and with GDP in the euro area declining by over 18%. Supportive policy measures are helping to mitigate the full impact of this decline on households and companies through short-time work and income support schemes, tax deferrals and credit guarantees (see below). However, any subsequent recovery is likely to prove slow and gradual even if, as assumed, the progressive relaxation of containment measures results in an initial improvement in the level of economy-wide output and renewed outbreaks of the virus do not occur. Many service sector companies are likely to have to operate well below full capacity for an extended period, with foregone consumption of the services during shutdowns unlikely to be regained. Some companies are likely to become insolvent, raising the risks of a further round of job declines, income losses and impaired assets on bank balance sheets at a time when emergency government schemes are currently due to have come to an end.

The renewed outbreak assumed to occur in the fourth quarter of 2020 in the double‑hit scenario results in substantial further easing in activity while it lasts (Figure 1.6). Global output is projected to fall by 4¼ per cent in the fourth quarter of 2020 in this scenario, and output in the OECD economies to decline by around 4½ per cent. This would leave the level of global output 11% lower at the end of 2020 than a year earlier, representing a large and sustained collapse in activity without precedent since the Great Depression. OECD GDP would be even weaker, 13% lower than at the end of 2019. Even if further policy support is provided, such a long period of stress on many companies, particularly in sectors where activity would be severely restricted once again, is likely to result in substantial and rising bankruptcies and job losses.

Figure 1.6. A collapse in output followed by a slow recovery

Figure 1.7. An unprecedented output collapse is occurring in the first half of 2020

Per cent change in GDP between 2019Q4 and 2020Q2

There are sizeable differences in growth prospects across the major economies (Figure 1.8), although output declines are projected in all of them this year. Moreover, in most, the level of output at the end of 2021 is projected to be below that at the end of 2019, and considerably weaker than past projections would have suggested (Figure 1.9).

Amongst the advanced economies, GDP is projected to be particularly weak in Europe this year, reflecting the implementation of stringent containment measures over a comparatively long period. Euro area GDP in 2020 is projected to be 11½ per cent lower than in 2019 in the double-hit scenario, and just over 9% weaker in the single-hit scenario. In the United States and Japan, GDP is projected to fall by 8½ per cent and 7¼ per cent respectively in the double-hit scenario, and decline by 7¼ per cent and 6% respectively in the single‑hit scenario. This reflects the later and shorter implementation and lower stringency of containment measures, both in the second quarter of 2020 and in the assumed renewed virus outbreak in the fourth quarter of 2020. Korea is a notable outlier amongst the larger advanced economies in 2020, with output projected to drop by only around 1¼ per cent relative to 2019 in the single‑hit scenario and 2½ per cent in the double-hit scenario, helped by less stringent and well-targeted containment measures. These cross-country differentials are reflected in the projections once recoveries get underway, with growth projections for 2021 typically stronger in those economies experiencing the largest output collapses from containment measures.
Many emerging-market economies and developing countries, particularly commodity producers, are experiencing considerable difficulties due to the dual health and economic crisis. The impact of the coronavirus pandemic is extremely challenging, with health systems often lacking the resources required to respond effectively, and plummeting commodity prices, declining remittances, weak external demand and tighter financial conditions compounding this challenge. The level of GDP in 2020 is projected to be 7% or more below that in 2019 in Brazil, Russia, South Africa and Mexico in both scenarios, and in Turkey in the double-hit scenario. Outcomes in some large emerging‑market economies in Asia are more muted. Smaller output declines of between 2½-4 per cent are projected in China and Indonesia in 2020 in both scenarios, helped by the beneficial effect of lower commodity prices on real incomes. India will also benefit from lower commodity prices, but is still projected to experience a substantial activity drop in FY 2020-21, with GDP some 7¼ per cent lower than in FY 2019-20 in the double-hit scenario and 3¾ per cent lower in the single-hit scenario. Output is projected to either be close to or above the end-2019 level in both scenarios (Figure 1.9), as in China and Indonesia, but this still represents a large unexpected shortfall in incomes given prior expectations for GDP growth of between 5-6% per annum.

Figure 1.8. Output is projected to decline in all economies this year

Annual GDP growth, per cent

Private consumption and fixed investment are both expected to decline sharply this year before slowly recovering in 2021. The collapse in activity in the first half of 2020 has been driven by lower consumer spending, reflecting the closure of non-essential businesses, avoidance of travel, and subdued confidence. At the same time, household saving has risen sharply, with labour incomes supported in many countries by government measures for furloughed employees. High uncertainty, weak confidence and employment declines are likely to keep precautionary saving elevated for some time, but spending levels should recover slowly as containment measures are relaxed and shops reopen. Weaker demand, elevated uncertainty and liquidity shortages are likely to weaken investment substantially this year and check the prospects for a rapid pick-up in 2021. In event of a renewed virus outbreak later this year, uncertainty would intensify further for an extended period, with additional precautionary saving, weaker household spending, and substantially softer investment prospects.

In the OECD economies, the level of consumer spending in 2020 is projected to be around 10¾ per cent weaker than last year in the double-hit scenario and 8½ per cent lower in the single-hit scenario, before picking up through 2021. The level of fixed investment in the OECD economies in 2020 is projected to be around 12¾ per cent weaker than in 2019 in the double-hit scenario, and 10½ per cent softer in the single-hit scenario.
Larger declines in investment are projected in many emerging-market economies, reflecting greater financial stress in some countries, highly-leveraged corporate sectors and sharp declines in confidence. In the double-hit scenario the level of investment is projected to decline by over 13% in 2020 in Brazil, India, Mexico, Turkey and South Africa.

Figure 1.9. Output is set to remain weak for an extended period

Fiscal actions help to support activity in 2020, both through special schemes to support incomes or employment during the shutdown, and through stronger final spending. In the OECD economies, government final consumption is projected to rise by between 4 and 4¼ per cent in 2020, after rising by around 2% per annum on average in 2018-19, with relatively strong growth in the United Kingdom, Korea, Australia, Japan and Germany. The exceptional additional monetary policy support measures introduced since the start of the pandemic are also important for economic stabilisation and limit debt service burdens as countries begin to ease containment measures, but are less likely to have strong effects on the subsequent pace at which domestic demand recovers (OECD, 2019a). There are many signs that the impact of very low interest rates and high asset prices on final domestic demand has been relatively modest in recent years, possibly because expectations of persistent low interest rates reduce the incentive to bring spending forward. Financial asset price gains are also relatively concentrated in households with a lower propensity to consume out of wealth.

Labour market conditions are projected to deteriorate significantly. Unemployment in the OECD economies, which had declined to a fifty-year low at the end of 2019, is projected to have more than doubled by the middle of this year to around 11½ per cent, well above the level seen during the global financial crisis (Figure 1.10). As economies begin to reopen, unemployment is projected to moderate gradually, but remain substantially above the level prior to the pandemic outbreak, reflecting the scale of immediate job losses in some countries, and the likely declines in employment in others as temporary wage and employment support schemes come to an end in the latter half of 2020. In the double-hit scenario, unemployment remains at high levels for even longer in the OECD economies after peaking at around 12½ per cent in the fourth quarter of 2020, raising the risk of hysteresis as long-term unemployment becomes entrenched, and diminished labour force participation from discouraged workers. The OECD‑wide unemployment rate is projected to be close to 9% at the end of 2021 in this scenario, still above the peak seen during the global financial crisis and 3½ percentage points above the rate at the end of 2019 (Figure 1.10). Significant slack in labour markets would in turn place further downward pressure on wage and income growth.

Job losses and subsequent re‑hiring are particularly pronounced in the United States, with the surge in the unemployment rate in April and May this year only easing to around 10% at the end of 2021 in the double‑hit scenario, and 8¼ per cent in the single-hit scenario. Sharp rises in unemployment are also projected in the United Kingdom and Spain, as well as in some smaller open economies, although temporary support programmes are cushioning labour incomes in the near term. Smaller changes are projected in Germany, France and Italy with job losses moderated by their respective schemes to support employment, and in Japan (OECD, 2020e; Chapter 2, Issue Note 5).

Figure 1.10. The crisis is resulting in sizeable job losses and high unemployment

World trade was already weak prior to the pandemic outbreak and is projected to decline by 11½ per cent in the double-hit scenario in 2020, and 9½ per cent in the single-hit scenario, before picking up in 2021 (Figure 1.11). Particularly sharp falls are projected in many European economies this year, reflecting strong cross-border linkages between economies and the strong importance of tourism exports in some, as well as in many commodity‑producing economies where external demand has declined significantly. Although the decline in global output this year is projected to be considerably greater than during the global financial crisis, the fall in world trade in 2020 as a whole is broadly comparable to that seen in 2009. In part, this reflects the relative concentration of the current crisis in service sectors, where trade intensity is lower than in manufacturing ones with extensive global value-chains, and the lower import intensity of consumer spending relative to fixed investment. Aggregate trade intensity has also stabilised since the global financial crisis. Global trade has risen only marginally faster than global output in recent years, whereas it was rising at more than twice the pace of output in the early 2000s.

Either of the two scenarios set out above are seen as potential developments over the next 18 months, but a wide range of other outcomes remains possible. More protracted lockdowns than currently assumed, particularly in some sectors such as travel and tourism, may be required to ensure that the number of new cases and deaths remains low. This would be likely to further deepen the hit to output this year. Additional, though more muted, infection waves could also occur through 2021, potentially necessitating additional containment measures and checking the pace of any recovery that year. On the upside, the current easing of containment measures in many countries could proceed more smoothly and quickly than assumed, with confidence recovering quickly, or an effective treatment could be found within a relatively short time period. Either of these would improve the prospects for a sustained recovery in output and incomes.

Figure 1.11. World trade is projected to remain very weak, with challenges for tourism-dependent economies

Inflation is expected to remain low

In advanced economies, annual consumer price inflation rates have fallen in early 2020, halving in many economies from end‑2019 to April-May, due to lower energy prices and despite some increase in food prices (Figure 1.12, Panel A). However, uncertainty about inflation measurement has increased given that many services have not been provided due to strict containment measures and many individual prices have been extrapolated by statistical offices (Bureau of Labor Statistics, 2020; Eurostat, 2020). Measures of inflation compensation derived from financial market indicators, in particular bond yield differentials, have declined significantly.

In the two scenarios, advanced economies’ consumer price inflation in 2020 and 2021 is projected to remain low and below 2019 levels (Figure 1.12, Panel A). In the euro area and Japan, temporary deflation is expected, in contrast to the United States, where inflation is projected to remain more resilient. In line with the developments seen in the global financial crisis, these projections reflect reduced pressures on wages due to high unemployment and weak consumer demand.4 The annual inflation rates in most emerging-market economies are expected to decline gradually over next 18 months, reflecting a dissipation of inflationary shocks from exchange rate depreciations, and higher food and administrative prices, as well as weak economic activity (Figure 1.12, Panel B).

Figure 1.12. Inflation is expected to remain low

Double-hit scenario

These projections are very uncertain, reflecting the specific nature of the ongoing crisis and possible ensuing negative supply-side effects, which are hard to predict at this stage. Containment measures and distancing regulations will impose costs on companies and reduce capacity, with negative implications for their profits. Thus, companies may attempt to raise prices to compensate for losses. The risk of such price‑setting behaviour is higher in the double‑hit scenario, especially with increased bankruptcies, and thus reduced competition and supply of some goods and services. These tendencies would be strengthened if there were persistent disruptions to international trade or new trade barriers (see below). However, it is uncertain if such supply-side effects would suffice to offset downward pressures from spare capacity in many sectors of the economy.

There is also an upside risk to inflation related to oil prices. Oil prices have collapsed in early 2020 due to the slump in demand, despite sizeable supply reductions by the largest oil producers. With oil prices at very low levels, reaching an agreement to cut supply significantly further could lead to a faster and larger rise in oil prices than assumed in the single‑hit scenario; the discrepancy between higher oil prices driven by supply restraints and the assumed constant oil price in the double-hit scenario, despite weaker demand, would be even more marked (Annex 1.A).

The large recession may leave multiple scars and there are risks it could last for longer

Five years or more of income growth could be lost in many countries by the end of 2021

The disruption resulting from the pandemic is likely to leave long-lasting scars in many economies. Living standards have been reduced significantly, unemployment is being pushed well above pre‑crisis levels, raising the risk of many people becoming trapped in longer unemployment spells, and investment is collapsing. The direct impact on people’s livelihoods is particularly severe among the most vulnerable groups in society (Chapter 2, Issue Note 4). Many of the service sectors hardest hit by the pandemic are relatively employment‑intensive, with many workers on low pay or non-standard contracts and in occupations where teleworking is more difficult (OECD, 2020f; Dingel and Neiman, 2020; Yasenov, 2020). Enforced shutdowns, reopening at lower levels of capacity, and changing consumer preferences and behaviour may mean that many businesses are no longer viable, with permanent job losses.

In the median OECD economy, real per capita income is projected to decline by 9½ per cent in 2020 in the double-hit scenario (Figure 1.13, Panel A), with substantial declines in all economies. Even with some recovery in 2021, real per capita income is only at the level of 2013 in the typical economy, and over 10½ per cent lower than anticipated in projections prior to the pandemic. In the single‑hit scenario, the income declines are smaller, but still leave real per capita incomes in 2021 at their lowest level since 2016.5
Unemployment in the median OECD economy this year is projected to be at the highest level for twenty-five years, and ease only slowly in 2021. The scarring effects from job losses are likely to be felt particularly by younger workers and lower-skilled workers, with attendant risks of many people becoming trapped in joblessness for an extended period.
The impact of the pandemic is set to weaken net investment further. Even prior to the outbreak, net productive investment (business plus government) in the median OECD economy was weak, averaging 4½ per cent of GDP over 2015‑19, some 2¼ percentage points below the net investment rate in the decade prior to the global financial crisis. Substantial further declines are projected in 2020‑21 (Figure 1.13, Panel B). This further raises the risks of weak output growth becoming entrenched.

The scars in labour and product markets, the need for some reallocation of workers and capital across sectors in the aftermath of the pandemic, and the significant adverse impact of the crisis on living standards emphasise the urgent need for renewed and well-targeted structural policy reforms in all economies. Governments are using a broad mix of labour market policies and corporate support schemes to protect the incomes of workers and businesses through the shutdown. Policy responses will need to remain flexible and agile for some time given differences in the pace at which various containment measures are being relaxed, and the possibility of renewed virus outbreaks. Activity in some sectors, such as aviation and tourism may be significantly lower for some time to come. Consumer preferences could also change permanently, accentuating the digital transition towards greater use of e‑commerce and the digital delivery of services.

Figure 1.13. The pandemic will leave long-lasting legacies

A key challenge will be to find ways of identifying and supporting viable jobs and companies in the near term whilst allowing sufficient flexibility for necessary resource reallocation to occur across sectors to minimise long-term scarring and restore productivity growth:

Short-time work schemes are effective in preserving existing jobs, but may be less efficient in facilitating post-crisis adjustment across sectors. Gradually raising the financial contributions from employers’ in these schemes could prove one way of identifying businesses who expect to remain viable for an extended period (OECD, 2020e; Chapter 2, Issue Note 5). In countries in which generous unemployment benefits are being used to support incomes, the challenge will be to find ways of restoring pre‑crisis job matches that become viable again once containment measures are ended and activity starts to recover. This could involve financial incentives for firms to undertake only temporary layoffs or rehire former employees.
More broadly, active labour market programmes and enhanced vocational education and training are needed to create opportunities for all, facilitate possible job reallocation after the removal of containment measures, and prevent the erosion of human capital. Enhanced childcare provision and improved efficiency and targeting of tax and transfer policies also need to be an integral part of well-designed policy packages to enhance participation and make the labour market more inclusive.
Government support for companies through wage subsidies, tax deferrals and guarantees will also need to be phased out gradually as containment measures are eased to ensure that unviable firms are not supported for an extended period (OECD, 2020f; Chapter 2, Issue Note 2). One option is to convert such deferrals into public equity stakes, although care should be taken to ensure this does not distort competition and that there are transparent and clearly defined conditional exit strategies for such investments (OECD, 2020g). Reforms to streamline insolvency procedures may also be needed in some countries to minimise barriers to corporate restructuring and spur productivity‑enhancing capital reallocation (Adalet McGowan et al., 2017).
In the medium term, reforms to spur business dynamism, addressing infrastructure shortages, and reducing policy uncertainty about the longer-term challenges from climate change, digitalisation and globalisation, would also strengthen incentives for businesses to invest and improve the prospects for sustainable gains in living standards.
It will also be important to balance the need for resilience with the potential reduction in efficiency that could result from policy measures designed to induce businesses to restructure their supply chains and reduce inputs from efficient but distant providers (see below).

Government efforts to support the economic recovery also need to incorporate the necessary actions required to limit the long-term threat from climate change. Existing environmental standards should not be rolled back during the recovery and sector-specific financial support measures should be conditional on environmental improvements where possible, such as stronger environmental commitments and performance in pollution-intensive sectors that are particularly affected by the crisis (OECD, 2020h). The potential for an extended period of substantially lower fossil-fuel prices than previously expected further raises the urgent need to introduce effective incentives for firms to invest in energy-efficient technologies.

Company insolvencies and financial market risks

A sharp drop in revenues of firms due to the shutdown of many sectors increases the risk of widespread defaults. Financial distress will depend on the extent and duration of disruptions stemming from containment measures and on consumers’ behaviour after the lifting of restrictions. Companies in some sectors, like hospitality, travel and tourism, where the lockdown will last longer and significant changes need to be undertaken in health and sanitary safety measures, may not recuperate revenues. The impact will also depend on companies’ ability to reduce fixed operating expenses to minimise operating losses, and to obtain new financing, as well as the size of their cash buffers and debt payments. Businesses with larger cash holdings, lower debt and easier access to alternative sources of external financing will fare better, as will companies in countries with government support schemes. Stylised simulations show that effective government interventions, including debt moratoriums, and tax and wage bill relief, could more than halve the share of firms facing liquidity shortfalls after a year if there is a protracted recovery (OECD, 2020f; Chapter 2, Issue Note 2).

While comprehensive firm-level data on the financial position of non-financial corporations are not available, the evidence for selected large companies suggests that the negative impact of the collapse in output will be very large, but heterogeneous across countries and sectors (OECD, 2020f; Chapter 2, Issue Note 2; Banerjee et al., 2020). This reflects, among other things, small cash buffers. Among listed and large unlisted companies in selected OECD and emerging‑market economies, as of end‑2019, 25% of firms did not have enough cash to cover all debt obligations falling due in 2020 (Banerjee et al., 2020). Moreover, the adjustment of operating expenses is usually much slower than of revenues and this time may be even more difficult given new costs arising from hygiene and safety measures. New external financing could help in the short term, but access can get more difficult over time and covering losses with new debt will increase already high leverage, creating problems for the future. Over recent months, companies have already drawn upon bank credit lines but these may become scarce due to deteriorating creditworthiness of borrowers and banks’ reduced willingness and capacity to extend loans.6 Access to debt finance might also be reduced, particularly for riskier companies. Global issuance of high‑yielding corporate bonds and leveraged loans, and debt issuance in Europe have already fallen drastically (IMF, 2020).

The likely rise in corporate insolvencies and bankruptcies may lead to negative feedback effects in corporate bond markets. Spreads for high-yield corporate bonds in the United States and the euro area have already increased to high levels (see above). Further sell-offs are to be expected, with downgrades due to deteriorating profits of businesses, especially for corporate bonds just above non‑investment grade (Çelik et al., 2020). If bonds issued by these companies are downgraded to non‑investment grades, regulations will prompt forced sales by some institutional investors, weighing negatively on corporate bond prices. Already, a record amount of debt has fallen to junk status in recent months. To limit stress of high‑yield corporate borrowers, the authorities could increase targeted lending to such debtors while limiting credit risks, and also consider retractable preferred equity investment in viable companies (Chapter 2, Issue Note 3).

Corporate financial difficulties could also add to challenges for banks, especially in Europe where companies depend on bank borrowing to a larger extent than in the United States and where banks in some countries were in a weak position entering the pandemic crisis. While banks are not at the origin of the ongoing crisis, and have higher capital and liquidity buffers than prior to the global financial crisis in 2008, they are likely to be affected negatively by increased corporate and household defaults as well as weak demand for new loans and very low interest rates. Higher perceived risks of banks are already evident. In some advanced economies, bank equity prices have declined by more than overall equity price indices and bank credit default swap spreads have widened rapidly. Price‑to‑book ratios have also declined significantly. In many European countries, they have at least halved from their 2017‑18 average levels and reached historical lows. Weaker bank earnings and rising non-performing loans, in the low‑growth and low‑interest environment, could constrain banks’ willingness to lend in spite of monetary policy support. Bank lending standards have already been tightened substantially in the United States, but only a little in the euro area so far.

The challenges facing emerging-market economies and developing countries

Emerging-market economies and developing countries remain highly vulnerable to the global recession and the coronavirus pandemic.

High indebtedness is a major vulnerability in many emerging-market economies and developing countries. Since the global financial crisis, debt has increased in relation to GDP in many countries (especially in China, Chile and Turkey for non-financial corporations; and in Argentina, Brazil, China, Chile and South Africa for governments). At present, it is very high by emerging‑market economy standards in Brazil, Chile and China (Figure 1.14, Panel A). Moreover, in Argentina, Chile, Mexico and Turkey, a significant share of loans and debt securities by non-bank borrowers is denominated in foreign currencies, primarily in US dollars (Figure 1.14, Panel B). Foreign ownership of corporate bonds issued in local currencies has also increased in some emerging‑market economies and developing countries (Çelik et al., 2019). This poses significant challenges when domestic currencies depreciate, foreign currency revenues drop and international investors are not willing to lend. Foreign currency reserves are generally not large (Figure 1.14, Panel C) and several countries have already had to intervene to defend their currencies.7 In some countries, the banking sector has experienced difficulties due to a high share of non-performing loans, including in India and Turkey.
To a varying degree, emerging-market economies and developing countries are heavily dependent on demand from advanced economies and China, via global value chains, with tourism and remittances being an important source of income.8 Commodity producers with limited financial buffers and low-income countries with underdeveloped domestic financial markets and a small domestic investor base are likely to be particularly affected.
Many emerging-market economies and developing countries have weaker automatic fiscal stabilisers, given less developed social safety nets and higher informality, and limited room for macroeconomic policy easing due to high public debt and inflationary pressures created by domestic currency depreciation. The compounded nature of the COVID-19 shock through reduced foreign demand, lower tax revenues and increased public spending requirements elevates the risk of twin-deficit crises in these countries.

Risk perceptions with respect to emerging-market economies and developing countries deteriorated as the COVID-19 crisis developed but have improved somewhat in a few cases in recent weeks. Exchange rates depreciated significantly, in Brazil, Colombia, Mexico, Russia and South Africa by as much as 20‑30%, which was generally less than at the peak of the global financial crisis, but have partially recuperated the losses (Figure 1.15). US‑dollar‑denominated government bond yield spreads over US Treasuries increased to their previous peak in 2009 (especially in Latin America) and the number of sovereigns with extremely high bond spreads exceed 2009 levels (Figure 1.5). Widespread portfolio capital outflows from emerging‑market economies and developing countries were at a record high, nearing USD 100 billion over a period of less than two months (IIF, 2020), dwarfing the scale of capital outflows during the global financial crisis. Many sovereign bonds have been downgraded or put on a negative outlook, including those issued by Colombia, Mexico and South Africa.

To ease financial pressures, G20 nations agreed to freeze bilateral government loan repayments for 76 low-income countries and called on private creditors to follow suit. In addition, the IMF approved SDR 17 billion (USD 24 billion) of emergency financing for 66 countries in the form of new concessionary lending (more than 100 countries have applied for such loans), and cancelled six months of debt payments due from 25 countries. While these measures offer a temporary respite, high debt level challenges remain and will intensify if the pandemic persists or returns and the global economy remains in recession. Moreover, debt relief from private creditors could be harder to obtain, as recent negotiations over Argentinian sovereign debt demonstrate. Thus, tensions will likely rise, with negative spillovers for some advanced economies and China, which has become an important creditor for many emerging-market economies and developing countries (Horn et al., 2019).

Figure 1.14. Vulnerabilities in emerging-market economies

Figure 1.15. Domestic currencies have weakened considerably against the US dollar

Percent change in the US dollar exchange rate

The consequences of the contraction in international trade

The crisis has demonstrated the vulnerability of domestic production to sourcing inputs from distant locations. Prompted by efficiency considerations, companies have outsourced production to exploit comparative advantages in performing different tasks, building up long and complex global value chains (GVCs). The latest data available show that foreign value added in production exceeded 50% in most economies and areas, with relatively strong backward linkages in manufacturing, especially in cars and electronics, and more forward linkages in services, such as banking and business services (Figure 1.16, Panel A). Due to regulatory harmonisation within the European Single Market and the common currency area, the exposure to cross-border European suppliers is particularly large for some small European countries. To the extent that such supplies are more secure than from other more distant foreign suppliers, the overall foreign exposure overstates the vulnerability of these smaller European countries to foreign supply disruption (Figure 1.16, Panel B).

Figure 1.16. Vulnerability to trade shocks is high in some OECD countries

While the increasing interconnectedness of economies is a source of resilience, it can also have the opposite effect, with an amplification of contagion throughout the system due to greater specialisation among partners or a reduced substitutability between products and suppliers (Jouanjean et al., 2017). Shocks propagate along the supply chain with different intensities according to the position of each industry in the network9 and require adequate buffers to prevent potential contagion. International diversification of foreign direct investment, suppliers and markets can support resilience if shocks (economic crisis or natural disasters) are not correlated or are country‑specific, but is less effective when a simultaneous set of shocks happens globally, as in a pandemic (Acemoglu et al., 2012).

The disruption to GVCs from localised supply problems was demonstrated in 2011, when the tsunami in Japan and flooding in Thailand resulted in shortages of difficult-to-substitute components further down the GVCs for the transport equipment sector and hard-drives, respectively.10 The shutdown in China early this year reportedly caused significant disruption for companies that relied on components supplied by China, notably those sourced from Hubei province, which is an important hub for domestic and international value chains. In Europe, where GVCs are particularly important, the lifting of shutdown measures at a different speed may result in input shortages.

If GVCs were to be shortened to reduce input sourcing risks and enhance resilience, some of the efficiency gains associated with expanding chains in recent decades would be foregone. Firms would lose some of the benefits from economies of scale and specialisation. At the same time, access to foreign markets might be compromised if the activities of affiliates abroad were to be downsized and the proximity to the strategic knowledge assets (e.g. research centres, universities, competitors) needed for fostering R&D and innovation investments could be reduced. Moreover, reshoring activities would weaken opportunities for productivity spillovers that stem from sharing technology and adopting more effective organisational and managerial practices (Criscuolo and Timmis, 2017).

Overall, empirical analysis suggests that increased GVC participation in the past, in both advanced and emerging-market economies, has been associated with significant productivity increases. A 10% increase in the level of imports of intermediates has been estimated to raise labour productivity by 2% and income per capita by 11-14% (Constantinescu et al., 2019). Given the rapid expansion of cross-border trade and the associated increase in world trade intensity since the 1990s (Figure 1.17), the potential cost of diminishing international trade in inputs could be high if supply chains were to shorten. In emerging-market economies and developing countries, the on-shoring of foreign production in advanced economies could reduce the benefits from GVC‑associated capital flows and access to international markets, human capital and knowledge.

Figure 1.17. Cross-border trade has helped to raise world trade intensity

The challenges from the shortening of GVCs come on top of other threats to international trade. Increased use of trade-restraining measures is damping the cross-border flow of goods and services. Notwithstanding measures to arrest an escalation of trade tensions, the sharp increase in bilateral tariffs on trade between the United States and China over the past two years has depressed the bilateral flow of imports and exports between the two economies. Furthermore, even the fulfilment of the US-China Phase I trade deal, which commits China in the coming two years to purchase a cumulative additional USD 200 billion of American goods and services in 2020-21 (on top of a baseline of USD 180 billion imports in 2017), may be undermined by weaker demand due to the pandemic. More generally, uncertainty about trade policy and the erosion of rules‑based procedures to settle trade disputes have weighed on trade, international investment and economic growth in recent years. In addition, the prolonged uncertainty about Brexit has also resulted in considerable trade volatility as well as large exchange rate fluctuations.

Policy requirements

In the short term, and possibly until a treatment or vaccine becomes available, the key policy challenge is to foster the recovery while some containment measures remain in place and some sectors undergo structural transformations. This requires a mix of policies that aid the reallocation of resources across sectors and support the incomes of workers and firms left in a precarious position. Extensive fiscal, monetary and financial policy responses will help underpin household incomes, employment and firms’ cash-flow, and minimise longer-lasting scars for the economy. However, policies will need to be flexible and agile given differences in the duration of shutdowns and recoveries across sectors, the possibility of further shutdowns and financial instability, uncertainty about structural changes to demand and supply in the economy, and the risk that the associated economic costs turn out to be long lasting. Policy design should also reflect the risk that the current crisis may aggravate many pre-existing policy challenges related to low growth, inequality and high public debt.

Greater global co-operation and co-ordination via the G20, the European Union and other groups is essential to track the spread of the pandemic, pool financial resources and share information on effective containment and treatment interventions. Acting together creates confidence and positive spillovers that will be more effective for all countries than if they acted alone.

Health policy priorities to reduce vulnerability

The immediate policy priority in most countries is to ensure adequate hospital capacity to deal with the current and potential future virus outbreaks; increase the supply of PPE for health professionals and the population at large; and to build up the infrastructure for an effective test, track and treat strategy.

The capacity of ICUs in the hospital sector, which came under intense pressure in dealing with the current outbreak in some countries and regions, needs to be enhanced. This has already be done in some of the countries most affected by the virus, and further expansion is being planned. Even so, building up additional capacity in these and other countries in coming months remains important so as to enable the hospital system to deal with a potential resurgence of infections without unduly delaying necessary interventions for other patients. In many emerging‑market economies and developing countries, ICU capacity is limited or negligible. In the longer term, most countries will need to review their healthcare system and make it better prepared to address future pandemics.
Large-scale testing capacity is a prerequisite for fully relaxing containment measures. Even if cross-country comparable data are lacking on this issue, available country‑specific data suggest that by end-April the number of tests relative to the size of the population differed considerably from one country to another (OECD, 2020c). However, some countries where testing has been comparatively low have ambitious targets for increased testing in the near term. Higher test capacity needs to be accompanied by an enhanced ability to trace individuals that have been in contact with an identified carrier; using new technology for this purpose will require addressing privacy concerns.
Increased availability of PPE for health professionals and the population at large should help to reduce the transmission of the virus. After shortages in many countries in the early stages of the pandemic, and an initial tendency to ban exports (OECD, 2020i), increased international trade in PPE and sharply stepped-up domestic production of such equipment has eased shortages. Further expansion to meet government targets, and ensuring that an adequate precautionary stock is maintained, will help to ease containment policies.

Countries have a mutual interest in maintaining open trade in medical products. Prior to the crisis, global exports and imports of such products amounted to 5% of world trade, with countries specialising in exports of particular products (WTO, 2020). For example, China, the United States and Germany accounted for 40% of all exports of PPE, and Singapore, the United States, the Netherlands and China provided more than half of all exports of respirators and ventilators. In some countries, supply shortages have prompted costly import-substituting domestic production that may prove difficult to wind down after the outbreak subsides. By interfering with global value chains, export curbs may also have weighed on production in the countries taking such measures. There are few signs that the export restrictions will be lifted in the near term.

Global co-operation and co-ordination are essential to tackle the severe health challenges all countries are facing. Joint measures and multilateral efforts are needed to ensure efficient production of medical products, and to ensure that affordable vaccines and treatments are widely and swiftly made available wherever needed. A far-reaching, shared, transparent information base and knowledge of best practices is also critical to support sound national policy responses and assess risks.

Monetary and financial policies

The crisis response and its effectiveness

Monetary and financial policies have been eased considerably in response to the pandemic and the ensuing financial market panic.

Many central banks have cut policy interest rates and committed to buy large amounts of sovereign and private assets to keep longer-term interest rates low (Figure 1.18; Table 1.2). In several economies, numerous measures to support liquidity in the financial sector and to boost bank lending to businesses and households have been implemented (Table 1.2).
To help ease pressures in global US dollar funding, six key central banks enhanced existing swap lines by extending the maturity, increasing the frequency and lowering the price of operations.11 The US Federal Reserve has also expanded currency swap lines with central banks in Australia, Brazil, Mexico, South Korea and elsewhere.12

Figure 1.18. The global monetary policy stance has been eased substantially

	Asset purchases	Lending support measures	Liquidity support measures
Bank of Canada	- Government of Canada Bond Purchase Program (CAD 55 bn) to address strains in the government bond market - Corporate Bond Purchase Program (CAD 10 bn) to support the liquidity and proper functioning of the corporate debt market - Commercial Paper Purchase Program (CAD 3 bn) to support the flow of credit to the economy - Canada Mortgage Bond Purchase Program (CAD 6 bn) to support mortgage lending	- Bankers’ Acceptance Purchase Facility (CAD 39 bn) to support financing of SMEs - Provincial Money Market Purchase Program (CAD 6 bn) and Provincial Bond Purchase Program (CAD 2 bn) to support a liquid and well-functioning market for short-term provincial borrowing	- Increase the frequency of Term Repo operations to ensure continuous functioning of financial markets - Temporarily increase bidding limit and ranges in the Government of Canada securities auction to support the liquidity and well‑functioning of financial markets - Contingent Term Repo Facility to provide liquidity against government securities as collateral - Broaden collateral eligibility to include mortgages for the Standing Term Liquidity Facility
Bank of England	- UK government and corporate bonds (GBP 200 bn) to ease domestic financial conditions	- Covid Corporate Financing Facility (GBP 325 bn) to provide funding to non-financial businesses - Term Funding Scheme (GBP 100 bn) with additional incentives for SMEs to improve the transmission of the reduction in Bank Rate to the real economy - Temporary extension to Ways and Means facility to provide a short-term source of additional liquidity to the government if needed to smooth its cash-flow	- Extension of the Contingent Term Repo Facility to provide additional flexibility in the Bank’s provision of liquidity insurance - Increase the Asset Purchase Facility gilt lending limits to mitigate operational frictions and support the Debt Management Office’s normal channels
Bank of Japan	- Government bills and bonds to stabilise the yield curve at a low level - Commercial paper and corporate bonds (JPY 20 tr) to ensure smooth financing of firms - Exchange-traded funds (JPY 12 tr) and Japan real estate investment trusts (JPY 0.2 tr) to lower risk premia of asset prices	- Accept corporate, SMEs and household debt as collateral under the Special Funds-Supplying Operations to Facilitate Financing programme (JPY 55 tr) to firmly support financial institutions to fulfil their function for a wide range of private sectors	- Provide ample yen liquidity using market operations with long maturities against pooled collateral - Provide ample US dollar liquidity - Temporarily increase the number of issues of Japanese government securities (JGSs) offered in the Securities Lending Facility and offers of sales of JGSs with repurchase agreements to stabilise the repo market
ECB	- Pandemic Emergency Purchase Programme (EUR 1.35 tr – public and private securities) to lower borrowing costs and increase lending - Temporary addition to the Asset Purchases Programme (EUR 120 bn) to ease financial conditions over the yield curve	- Pandemic Emergency Longer-Term Refinancing Operations - Temporarily broadened the collateral base, reduced valuation haircuts and removed credit quality requirements of collateral to support access to credit for firms and households	- Additional longer-term refinancing operations to provide immediate liquidity support to banks
Federal Reserve	- Treasury securities, agency mortgage-backed securities and agency commercial mortgage-backed securities to smooth functioning of credit markets	- Primary and Secondary Market Corporate Credit Facilities and Term Asset-Backed Securities Loan Facility (USD 850 bn) to support credit to employers - Municipal Liquidity Facility (USD 500 bn) to help state and local governments manage cash-flow - Main Street Lending Program (USD 600 bn) to support lending to small and medium-sized businesses - Exchange Stabilization Fund (USD 300 bn) to support credit to consumers, and businesses - Accept loans made under the Small Business Administration's Paycheck Protection Program as eligible collateral to support access to credit for small businesses - Modified the Liquidity Coverage Ratio rule to support participation in the Money Market Mutual Fund Liquidity Facility and the Paycheck Protection Program Liquidity Facility to support credit to households and businesses	- Expand overnight and term repurchase agreement operations to support effective policy implementation and the smooth functioning of short-term US dollar funding markets

Source: Bank of Canada; Bank of England; Bank of Japan; European Central Bank; and Federal Reserves.

	AUS	CAN	FRA	DEU	ITA	JPN	KOR	GBR	USA
Counter-cyclical capital buffer lowered			X	X				X
Systemic risk or domestic capital buffer lowered		X
Use of other capital buffers	X	X	X	X	X	X	X	X	X
Use of liquidity buffers	X	X	X	X	X	X	X	X	X
Less stringent loan provisioning	X	X	X	X	X	X	X	X	X

1. “Loan provisioning” includes temporary changes in the definition and treatment of non-performing loans during the COVID-19 crisis.

2. “Use of liquidity buffers” includes temporary easing in the calculation of the Liquidity Coverage Ratio and the Net Stable Funding Ratio.

Source: European Central Bank; and national supervisory authorities.

In order to support bank lending, the authorities in many advanced economies and large emerging‑market economies also eased bank prudential regulations (Table 1.3). Actions included lowering counter‑cyclical or systemic risk capital buffers and reserve requirements; allowing banks to operate below required capital and liquidity levels; delaying implementation of new regulatory measures, stress testing and regulatory reporting; easing collateral eligibility rules; and providing more flexibility with the treatment of non‑performing loans. Prudential supervisors in many countries have also encouraged banks to help borrowers affected by the pandemic to restructure loans and grant moratoria on loan repayments to small businesses and individuals. Several governments have provided extensive state‑guaranteed loan programmes involving commercial banks.

The swift actions by central banks in the main advanced economies, in particular in the United States, have led to a massive increase in market liquidity, helping to ease stress in financial markets and minimise risks of a systemic financial meltdown triggered by containment measures. While maintaining sufficient liquidity and financial stability is key at this stage of the crisis, the implemented measures should also eventually support the supply of credit in the economy and the economic recovery.13 However, already low interest rates before the pandemic and high debt in the corporate sector could reduce the effectiveness of monetary policy compared with normal times.

Policy requirements in the two scenarios

The current numerous monetary and financial policy programmes offer sufficient flexibility to deal with a return of the pandemic, associated disruptions to the economy, and heightened financial market volatility. In this event, many of these programmes could and should be scaled up or extended, particularly liquidity and lending support. A further expansion of US dollar funding swap lines, potentially including more emerging-market economies, may also be necessary. However, in the case of a prolonged global recession, it will be more challenging to minimise financial stability risks. Capital buffers of financial institutions are likely to be used up, bankruptcies will be much larger and there may be limits if support is needed for an increasing number of sectors of the economy. Depending on the size of these effects, formal government support to banks may be needed. Any further easing of prudential regulation should be done conditional on transparent disclosures of financial exposures and restrictions on dividend payments and bonuses.

If the pandemic is over and the associated lockdowns are phased out gradually, as assumed in the single‑hit scenario, some scaling back of liquidity support can be envisaged in advanced economies.14 Nevertheless, monetary policy should remain very accommodative, with low interest rates and lending support measures, to ensure access to low‑cost financing for the private and public sectors. This stance is appropriate given the projected weak recovery and likely subdued inflation in the medium term. Inflation is expected to remain low in the absence of protracted supply cuts (including oil), reflecting subdued demand, though this may raise challenges for the future (see below). But if inflation were to increase substantially and persistently, monetary policy could consider removing some of the stimulus.

Responding to upward pressure on bond yields

If government bond yields – which affect the pricing of credit in other segments of financial markets – were to increase, central banks have several ways to react. Policy interest rates could be cut if there is still scope, forward guidance on interest rates could be provided, and asset purchases could be increased. To maintain low yields at longer maturities, central banks could also opt for yield curve control, similar to that pursued by the Bank of Japan.15 This framework helps to control the price of longer‑term government bonds directly, in contrast to standard quantitative easing which focusses on the quantity of assets purchased.

The ECB could still face challenges with controlling bond yields in individual member states as government bond purchases continue to reflect ECB capital shares. However, the flexibility of asset purchases over time, across asset classes and among jurisdictions introduced through the Pandemic Emergency Purchase Programme will help the ECB ensure that monetary policy is transmitted in a more symmetric way across the euro area.16

Mounting policy challenges

Prolonged monetary policy support, although necessary in the context of the most severe global downturn since the Great Depression, will aggravate many of the pre-crisis policy challenges.

The transmission of monetary policy could become impaired by weaker bank profitability and balance sheets. A deep and prolonged recession, as in the double-hit scenario, and a long period of low growth, low or negative interest rates, and flat yield curves, will all affect banks negatively. In some European countries, these would aggravate pre-crisis challenges with high non-performing loans and long‑standing structural problems of low cost efficiency, limited revenue diversification and bank overcapacity (ECB, 2018). The likely heightened levels of non-performing loans will require strict prudential supervision, effective and fast insolvency procedures and the development of distressed debt markets, or the establishment of a “bad bank”.
The needed easing of prudential regulation during the crisis will have to be reversed gradually to rebuild capital and liquidity buffers. A sound financial system will be key for future monetary policy transmission and resilience during the next downturn.
The prolonged period of low growth and interest rates will also continue to challenge the solvency of pension funds and insurance companies. Low discount rates increase the present value of the liabilities of defined-benefit pension funds and life insurance companies (OECD, 2015; OECD, 2016). The adverse effects of low interest rates for pension funds are greater for funds that already had unfunded liabilities before the crisis. Funding gaps of pension funds have risen since the global financial crisis, and were already at around 30% of total assets in the United Kingdom and the United States in the mid-2010s, aggravating challenges stemming from gains in longevity (IMF, 2016).
The expected crisis-related increase in government debt and central bank assets may lead to perceptions of eroded central bank independence, with potential negative implications for inflation expectations. To minimise such risks, fiscal and monetary authorities should jointly communicate their commitment to central bank independence, and ensure a clear separation of their respective mandates, with that of monetary policy remaining focused on the inflation objective. Central banks’ total assets have already risen to record highs, especially in the United States where the nominal value of total assets has expanded by nearly 70% since early March (Figure 1.18, Panels B and C). They will increase further with continued purchases of assets and a higher take-up of programmes to support lending and liquidity. Moreover, some central bank measures to support non‑financial corporates and local authorities have distributional consequences, leading to perceptions that monetary authorities are encroaching on tasks reserved for elected governments. Higher credit risks taken may lead to capital losses in the future and increased political criticism and interference.17

Fiscal policy: Emergency measures and future priorities

The crisis response and short-term policy requirements

OECD fiscal balances and public debt are projected to deteriorate dramatically in 2020‑21 in both scenarios, reflecting large support measures (Box 1.2) and automatic stabilisers:

In the double-hit scenario, headline balances are projected to deteriorate dramatically in 2020 (Figure 1.19, Panel A), by about 9% of GDP in the median OECD economy, i.e. around three times as much as in 2008-09. In 2020, in several countries, the deficits are expected to be particularly high, including in the United States, the United Kingdom, Japan and Italy. The relatively small improvement in fiscal positions in 2021 in the double‑hit scenario reflects some carry-over of discretionary measures, as well as the workings of automatic stabilisers. In the single‑hit scenario, fiscal deficits are somewhat lower than in the double-hit scenario (Figure 1.19, Panel B), by around 2% of GDP in 2021 in the median OECD country. This is because the costs of discretionary programmes are lower, and mostly concentrated in 2020, and automatic stabilisation effects are weaker.

Figure 1.19. Fiscal positions are set to deteriorate drastically

The projections for the public debt ratio reflect the deterioration in headline fiscal balances, as well as lower GDP (the denominator of the ratio) and additional off-budget support measures that affect governments’ financial assets (e.g. loans, recapitalisations of firms and equity acquisitions). In the double-hit scenario, the median debt ratio increases by almost 15% of GDP in 2020, compared with the increase of 10% of GDP in 2009. Debt continues to rise in 2021, reaching 87% of GDP (Figure 1.19, Panels C and D). In Japan, Greece, Italy, Portugal and Spain, debt ratios peak at extremely high levels. For these countries, the projected 2021 debt levels are around 20-35% of GDP higher than they were in 2019. In the single‑hit scenario, the debt-to-GDP ratio rises by slightly less.

Box 1.2. Government responses to the pandemic crisis

The main measures taken by governments in response to the pandemic crisis involved (Figure 1.20):

On the spending side, besides extra spending on healthcare, the most common measures with a direct impact on budget balances aim to help preserve incomes and employment via short‑time work schemes and wage subsidies to laid-off workers and the self‑employed; extended unemployment benefits (including benefits for the partially unemployed), sick leave and other types of leave (e.g. via expanding the eligibility criteria or duration); and by providing additional support for child or other care needs. Governments are also providing additional transfers to households, the self-employed and firms, and topping up spending on public services other than health (e.g. active labour market policies or education). In most countries, spending measures account for the bulk of the direct budget changes.
On the revenue side, many countries have reduced taxes or social security contributions temporarily, either directly or by relaxing rules determining the tax base for firms (e.g. by extending loss carry-back or depreciation allowances). In addition, many countries have deferred taxes and social security contributions for individuals and firms and some have brought forward payments of their liabilities to households and firms, such as tax credits, to support liquidity. A few countries have made withdrawal of pensions easier (e.g. early withdrawal, lower thresholds) or made borrowing from them possible (e.g. the United States, Australia). While deferred payments will not impact government balances directly according to national accounting rules, they will increase public borrowing requirements temporarily.
Furthermore, most governments announced extensive off-budget support in the form of loans and recapitalisations (provided either directly by the government or state‑dependent development banks and special support funds), and loan guarantees.1 In fact, in many economies, the largest part of the stimulus is accounted for by large state loan guarantees (around 15% of GDP in the United Kingdom and over 25% of GDP in Germany).
To support the hardest-hit sectors (e.g. tourism, hospitality, aviation, culture, exporters or automotive), several countries have implemented a wide variety of measures, some consisting of programmes applied to the whole economy with specific amounts singled out for certain sectors, and others having more tailored forms. For example, Italy extended its social safety net to seasonal workers in tourism and entertainment and granted a special one-off compensation to those of them who lost their jobs due to the pandemic. Several countries set up special loan and/or guarantee programmes for the hardest-hit industries, for example Finland, Norway and Sweden (aviation) and Canada (agricultural and food processing businesses). Other governments temporarily waived or reduced certain payments for specific industries (e.g. ground lease rents for airports in Canada; taxes on hospitality in the United Kingdom and Iceland; temporarily lower VAT for restaurants in Germany). Countries also provided direct subsidies, e.g. to agricultural businesses, restaurants or cultural providers, including in Finland, the Netherlands and Portugal. Support to tourism included subsidised holiday vouchers for employees (e.g. in the Czech Republic) and marketing campaigns to promote the country as a tourist destination (e.g. in Iceland). Some countries combine the pandemic response measures with other long-term goals, such as environmental transition. For instance, in France, a planned increase in consumer bonus and car scrapping subsidies aim not only to help the hard‑hit automotive sector, but also to lower pollution and promote the usage of electric vehicles. Besides specific industries, almost all countries have set up specific programmes (providing grants, loans and/or guarantees) targeting SMEs (OECD, 2020j; OECD Covid tracker).

Figure 1.20. Frequency of government measures in response to the pandemic crisis

Number of countries adopting indicated measures

1. Governments in some countries have also encouraged private companies to grant moratoria on payments, e.g. of debt service and interest payments, rents or utility bills. These measures are not included in public finances though.

Notwithstanding the sharp projected deterioration in public finances, they could turn out even worse than expected due to large uncertainties about the economic impact of the crisis, the use of support measures, and the realisation of contingent liabilities. Public expenditure related to automatic stabilisers and special government support programmes may be much higher than projected if the economy turns out weaker, the programmes are extended or the take‑up of short-time work schemes and income support measures is larger than expected. There may also be strong political pressures to maintain generous support programmes after the pandemic is over. Moreover, extra fiscal costs could arise from realising losses on contingent liabilities – such as current state loan guarantees.18

The effectiveness of fiscal stimulus and the need for specific measures will change over time, increasing trade-offs between the need to support the economy, the need to foster the reallocation of resources to sectors with better longer-term prospects, and fiscal costs.

During the lockdown and the early stages of the exit, the main aim of fiscal support is to limit the economic damage from the pandemic and the associated containment measures. Fiscal multipliers are likely to be near zero during a full shutdown, as government programmes may not boost private consumption and investment much given administrative restrictions on economic activity. Instead, the main goal of the policy response is to preserve jobs and household incomes, and protect firms from bankruptcies. Minimising administrative delays in activating these programmes is of utmost importance if they are to be as effective as possible. As the containment restrictions are lifted, fiscal multipliers will likely strengthen, helping to stimulate demand and reduce hysteresis effects.
Firms facing transitory drops in demand and supply-chain disruptions require liquidity support that can be addressed by grants, credits or loan guarantees. These measures can prevent firms’ liquidity problems from turning into solvency issues. However, they may turn out to be costly and ineffective if support is provided to non-viable firms. To minimise the risks, the programmes should be evaluated over time and adjusted if needed, sufficient loss provisions that are reflected directly in budget balances should be made, and repayment incentives should be introduced (e.g. partial guarantees).

If a second outbreak of the pandemic materialises (as in the double-hit scenario) or economic growth and employment turn out even weaker than in the two scenarios, the scope and duration of support policies may need to be extended, while becoming more targeted. New support measures for firms might include equity‑like risk sharing instruments, such as cash‑against‑tax surcharge schemes (Boot et al., 2020), to provide firms with the required liquidity but without increasing their leverage. These kind of interventions are especially important for SMEs, which face more challenges in raising funding in a slowdown, and have positive repercussions on the stability of the banking system. Flexibility and agility will be crucial. Decisions to intervene will need to take into account the expected marginal costs and benefits, the strength of the automatic stabilisers and available fiscal space. The latter aspect will essentially depend on the reaction of monetary policy.

Several new EU initiatives have been proposed to support the most affected countries and address divergences arising from the pandemic shock (Box 1.3). These proposals are very welcome; their effectiveness will depend on their ultimate design, size and use, which are still under discussion. If needed, additional solutions could be considered (Boone and Pereira, 2020).

Box 1.3. EU programmes to address the economic consequences of the pandemic

EU and euro area bodies have come up with several welcome initiatives to help member states, especially those hard-hit by the pandemic and with less fiscal space, to finance fiscal measures in response to the crisis at a relatively low cost, limiting the implications for national debt burdens.

A European Stability Mechanism (ESM) Pandemic Crisis Support – a low conditionality credit line that euro area countries can access to receive loans of up to 2% of their 2019 GDP and at a maturity of up to ten years. This is a welcome breakthrough but the programme on its own may not be enough. The size of the credit line is modest in the current context, and the lack of automaticity of support (requiring a new eligibility assessment by the Commission, and subsequent approval by the ESM Board of Governors) may deter countries from applying.
The European Investment Bank’s pan-European guarantee fund of EUR 25 billion to facilitate up to EUR 200 billion of loans primarily to SMEs is welcome but may not provide sufficient help to high-risk small and very small enterprises.
A temporary Support to mitigate Unemployment Risk in an Emergency (SURE) programme to fight unemployment in the European Union has been set up. This is an appropriate initiative that could contribute to smoothing economic activity of member countries by helping finance national short-time work schemes. However, the programme is based entirely on loans and does not address challenges with limited fiscal space, beyond offering low rates. Moreover, its size is limited to deal with large union-wide shocks (EUR 100 billion, or 0.7% of the EU27 2019 GDP). In the future, introducing a permanent common fiscal capacity to smooth negative employment shocks without overburdening national budgets and debt ratios could be considered (Claveres and Stráský, 2018).
The European Commission has proposed to reinforce the EU budget with an exceptional and temporary EUR 750 billion recovery plan, comprising around EUR 450 billion of grants, EUR 50 billion of guarantees and EUR 250 billion of loans. The exact distribution of funds across member states and programmes is not yet known and may be subject to some form of conditionality. The bulk of the resources (around 80%) should support public investment, notably for the green and digital transformation, and key structural reforms in countries and regions where the crisis impact and resilience needs are the greatest. The plan would also include other tools, such as a solvency support instrument to provide urgent support to sound companies hit by the crisis, and a healthcare programme to strengthen health security and to prepare for future crises. The recovery plan is to be funded mainly via one‑off borrowing in financial markets on behalf of the European Union. Repayments (to take place between 2028 and 2058) will depend on the possible creation of new taxes at the EU level to address climate change and fair taxation in a globalised world (such as digital taxes). Disbursements of funds are expected in early 2021.

Options for dealing with high public debt in the longer term

The projected high level of budget deficits and public debt in 2021 will exacerbate pre‑crisis public finance challenges and may increase fiscal vulnerabilities in many OECD economies. A one‑off shock to the level of debt may not on its own endanger debt sustainability when economies recover: what matters is the dynamics of the debt that must be controlled. In the aftermath of the crisis, an excessively quick fiscal consolidation could stifle growth excessively, as some OECD countries experienced after the global financial crisis. But a lack of focus on ensuring debt sustainability once the recovery has firmed would also be an important risk.

Low debt servicing costs will reduce financing pressures but will not prevent debt accumulation on their own. Since the global financial crisis, monetary policy stances have been very accommodative with the aim of bringing inflation back up towards its target. The resulting low interest rates and increased central bank holdings of government bonds (Figure 1.21) have reduced government debt servicing costs significantly. This accommodative monetary policy stance will likely have to be maintained for several years given the time it may take for production capacity, income, employment and inflation to recover after the pandemic. If needed to attain central banks’ mandates, more accommodative monetary conditions can be ensured via additional net purchases of government bonds, yield curve control and strengthened forward guidance, with varying implications for government debt servicing costs over a long period.

Figure 1.21. Several central banks have become dominant holders of domestic government bonds

Per cent of total outstanding marketable bonds

Higher economic growth and inflation would lower the debt-to-GDP ratio on their own. Towards this end, governments should implement ambitious structural reforms to boost potential growth (OECD, 2019b). However, the experience from the past decade suggests that achieving higher growth quickly through structural reforms may be challenging without monetary and fiscal support. Similarly, raising inflation to target and keeping it there may require persistent monetary and fiscal support.

Reviewing all government expenditure will be necessary to ensure adequate spending on high‑priority areas and people, and enhance growth without threatening debt sustainability. First, healthcare spending will need to be boosted in many countries, both to increase the capacity to respond to future pandemics and to address structural increases in healthcare costs (Lorenzoni et al., 2019).19 Second, after a decade of low public capital spending, it is necessary to increase high-quality public investment in sectors related to digitalisation, education and climate change mitigation. Market failures in these sectors cause private under-investment, preventing large positive externalities and the attainment of important social objectives. A reduction in public investment should be avoided, in contrast to the past large consolidation episodes (Blöchliger et al., 2012). Third, governments will have to address rising costs related to population ageing (OECD, 2019c).20 Finally, there may be political pressure to sustain more generous social benefits and protection of workers’ income to better accommodate future downturns. Starting a review of public expenditures early is important because reallocation of spending towards priority areas is usually gradual.

At the same time, once economies have recovered from the crisis, higher government revenues will also be required to support debt sustainability in some countries, while enhancing the progressivity of the tax system and supporting climate change mitigation. This calls for a comprehensive review of countries’ tax mix, taking into account growth considerations, as well as inclusiveness and sustainability, which may have a greater weight in fiscal policy-making after the crisis. Revisiting the taxation of capital (from capital income to capital gains and property taxation) should be considered in the light of growth objectives, making the system more progressive where necessary. Consumption taxes were largely used in the aftermath of the global financial crisis and room for manoeuvre may be limited but should be explored where possible. Whilst care should be taken over the distributional effects, the use of carbon taxes should be increased, and fossil fuel subsidies reduced. This would not only address serious market failures, helping to bring about urgent changes in the economy to mitigate climate change (Marten and van Dender, 2019; OECD, 2020h), but would also provide revenues to compensate households and small businesses hardest hit by the measure. Addressing the tax challenges from the digitalisation of the economy and ensuring that multinational enterprises pay a minimum tax would strengthen revenue raising capacity and could be seen to contribute to fair burden sharing. Policy co‑ordination in this area will make reforms more effective, including by fighting tax avoidance and ensuring that tax disputes do not turn into trade wars, which would harm recovery even further (OECD, 2020k).

The adoption of well-designed fiscal rules, and a reformed budget process that strengthens incentives for prudent long-term planning and provides better information, would help shape budget decisions. Establishing, or reinforcing, independent fiscal councils and creating specific budget tools like the long‑term fiscal target established with the Enzi-Whitehouse budget reform legislation in the United States could be helpful in this respect.21 In the European Union, reforms of fiscal rules will be needed to ensure that a counter-cyclical fiscal stance is permissible in downturns while preserving fiscal sustainability. This may involve replacing the current multiplicity of numerical rules with an expenditure rule, possibly anchored to a debt-ratio target (Claeys et al., 2016; Darvas et al., 2018; OECD, 2018).

Policy priorities in emerging-market economies

Several large emerging-market economies have already eased their monetary policy stance and announced fiscal measures (Figures 1.18 and 1.19). Further policy responses will depend on the duration and magnitude of financial market stress, the impact of lower oil prices, negative international demand spillovers, domestic disruptions due to the pandemic, the extent to which vulnerabilities have built up before the crisis, and the policy space available to mitigate the negative shocks.

Emerging-market economies with a credible macroeconomic policy framework, flexible exchange rate arrangements and manageable exposures to foreign-currency-denominated debt, should continue to accommodate the shock. On the monetary policy side, this would involve further reductions in policy interest rates and looking through any temporary increases in inflation due to one-off depreciations of domestic currencies. However, already low real interest rates may make further monetary policy easing difficult in some countries, as additional exchange rate depreciation may fuel inflation and increase financial stability risks related to high foreign currency debt (Figure 1.14). In these cases, reserve requirements can be lowered as a counter‑cyclical policy instrument (Cordella et al., 2014). On the fiscal side, the automatic stabilisers should be allowed to operate fully. Some further temporary fiscal stimulus could be considered with little longer‑term implications for government debt.
In contrast, countries with weaker macroeconomic fundamentals may have no choice but to limit macroeconomic policy support, with negative implications for domestic demand. If access to international credit is difficult or very expensive, they should seek extra borrowing from international institutions and negotiate debt payment moratoria or restructuring with international creditors, with the aim of minimising disruptions to growth and maintaining future access to credit markets.22 On the fiscal side, medium-term fiscal frameworks, possibly supported by fiscal rules or fiscal councils, should encompass all fiscal and quasi-fiscal activities to help strengthen the quality and transparency of macroeconomic policy frameworks.
Although flexible exchange rate arrangements generally reduce external shocks in emerging‑market economies, excessive exchange rate volatility may undermine financial stability.23 When such risks are high, transparent and temporary interventions may be needed. When considering interventions, their possible limited effectiveness in addressing a persistent shock and limited foreign currency reserves should be taken into account (Basu et al., 2018). In extreme cases of financial crisis, capital outflow restrictions may be inevitable but they should not delay necessary adjustments to address underlying imbalances. In contrast, countries could ease capital inflow restrictions imposed on foreign currency operations by domestic financial institutions, including via reducing foreign‑currency reserve requirements (OECD, 2020l).24

Policies to avoid forfeiting the benefits of globalisation

Policymakers need to take co-ordinated action to keep trade and investment flowing freely to prevent the mounting threat of a reversal in globalisation. Co-operation to lower trade tensions and to remove tariffs and additional costs on firms and consumers is essential to mitigate the damage to activity and avoid further income losses for households and companies already hit by the crisis. Similarly, governments should refrain from introducing export restrictions on essential goods which could undermine confidence in global markets, create panic-buying and price volatility and harm import-dependent countries (OECD, 2020m).

The current crisis has also put a strain on international supply chains. Their resilience should be stress tested on a regular basis to identify particular weaknesses and ensured by companies and governments through the development of strategic stocks and upstream agreements for the reconversion of assembly lines during critical times. Investment policies should foster the broader adoption of digital infrastructure and transport facilitation to help bridge distances and reduce trade costs along production chains, and resolve disruptions in face-to-face processes. Governments can support businesses in upgrading their industrial strategies through regulatory flexibility that helps to promote innovation and supply diversification, and through the extension of credit support programmes designed to improve the efficiency of logistics. Finally, preserving cross-border trade is particularly important for poorer countries susceptible to food and medical supply shortages. Therefore, co-operative agreements on regional stockpiling and health‑emergency assistance in advanced economies should be designed in an inclusive way that also takes into account the needs of the most vulnerable countries. It is particularly important that emerging‑market economies and developing countries are not cut off from the global value chains that improve their growth prospects by providing access to international markets, human capital and knowledge.

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Annex 1.A. Policy and other assumptions underlying the projections

The two epidemiological scenarios that serve as a basis for the two economic scenarios are set out in the main text.

In both economic scenarios, the projections assume unchanged exchange rates from those prevailing on 15 May 2020: one US dollar equals JPY 107.1, EUR 0.92 (or equivalently one euro equals USD 1.08) and 7.10 renminbi.

In the double-hit scenario, the price of a barrel of Brent crude oil is assumed to remain constant at USD 30 throughout the projection period. In the single-hit scenario, the oil price is assumed to increase in line with forward market prices to USD 42 in the last quarter of 2021. Non‑oil commodity prices are assumed to be constant over the projection period at their average levels from April 2020 in both scenarios.

The projections for the United Kingdom are based on an assumption that a basic free trade agreement for goods with the European Union comes into force from the start of 2021.

The cut-off date for information used in the projections is 4 June 2020.

Notes

← 1. The Spanish flu is estimated to have infected 500 million people, a third of the global population at the time, and caused at least 50 million deaths (Johnson and Mueller, 2002; Taubenberger and Morens, 2006). In contrast to the current COVID-19 pandemic, the Spanish flu took a heavy toll on working-age people, with around a half of all deaths estimated to have occurred among individuals aged between 15 and 40 (Simonsen et al., 1998).

← 2. For example, reported COVID-19 deaths may be confined to hospitals and other healthcare establishments in some countries and more broadly in others, and there may be variations in recording the cause of death when diseased persons have multiple health issues in addition to the virus infection.

← 3. The definition in OECD health statistics on “Curative care (acute care) beds in hospitals” is broader than ICU beds, and the number of beds is typically of an order of magnitude larger than the number currently referred to for ICU bed capacity.

← 4. Among large advanced economies, the decline in inflation rates in 2009 and 2010 was driven by services, with the duration of this effect varying among countries.

← 5. Real income per person (2015 PPPs) in the median OECD economy in 2021 is respectively USD 1700 (3¾ per cent) and USD 3500 (8¼ per cent) lower than in 2019 in the single-hit and double-hit scenarios.

← 6. The use of credit lines by companies in some advanced economies has almost doubled since the last quarter of 2019.

← 7. Brazil, Chile, Colombia, India, Indonesia, Mexico, Russia and Turkey have already intervened to strengthen their currencies in response to the crisis.

← 8. Global remittances to low and middle-income countries could decline by nearly 20% in 2020 (World Bank, 2020a).

← 9. Upstream participants face greater demand volatility than downstream ones and therefore are at a higher risk of output reduction amplified by the adjustment of inventories to new expected levels of demand (the so-called “bullwhip effect”). Similarly, a shortage of available intermediate inputs following a supply shock sets off a “domino effect” propagating across all downstream industries, which intensifies with the length of linkages.

← 10. The estimated cost of the Japanese catastrophe for the transport equipment sector amounted to USD 139 billion (in value added), with Japan accounting for about 40% of the losses, the United States for 25%, China for 8%, the European Union for 8%, and Canada for 7% (World Bank, 2020b). At the time of the floods in Bangkok, 45% of the world manufacturing production of computer hard disks was located around the city, with an estimated loss of 30% of the world supply of hard drives that year (OECD, 2014).

← 11. The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve and the Swiss National Bank.

← 12. The ECB has set up euro swap lines with Bulgaria and Croatia. The Bank of Japan has set up a bilateral swap line with the Bank of Thailand in local currencies.

← 13. Bank credit to non-financial corporations have already increased substantially in the euro area and the United States, reflecting firms’ strong demand for cash, but consumer loans have declined.

← 14. The Bank of Canada has already announced the scaling-back of some of its market operations as short-term funding conditions improved considerably.

← 15. Japan has been targeting 10‑year government bond yields for almost four years already. A similar suggestion has been made in the United States, although focusing on shorter maturities (Bernanke, 2016; Brainard, 2019).

← 16. In an extreme case of persistent and high spreads threatening financial and economic – and thus price – stability, the ECB could use unlimited interventions under the Outright Monetary Transactions scheme if a member country applies for a European Stability Mechanism programme.

← 17. In principle, central banks could function with negative equity (Buiter, 2008). Some central banks have mechanisms to prevent capital losses by deferring future transfers to governments or are officially indemnified by fiscal authorities against potential losses.

← 18. Under the assumption that the whole amount of state guarantees, announced as of 13 May, were fully allocated and bore a 90% guarantee on the value of the loan, a default on 10% of the guaranteed loans would generate fiscal costs of around 0.8% of 2019 GDP in Spain, 1.2% of 2019 GDP in France, and 2.7% of 2019 GDP in Italy.

← 19. Across the OECD countries, health spending is projected to increase on average by 1.4% of GDP between 2015 and 2030 (Lorenzoni et al., 2019).

← 20. Across the OECD, public pension expenditure is projected to increase on average by 0.6% of GDP between 2015 and 2050 (OECD, 2019c).

← 21. The Enzi-Whitehouse bill (November 2019) introduces fiscal goals in the US budget resolution, a blueprint for the actual appropriation process defined in the budget, in the form of targets for the ratio of debt held by the public relative to GDP. Debt-increasing legislation will automatically require adjustments, as well as a special legislation process, to reconcile the budget with the targets. Explicit long-term sustainability targets could give policymakers more ownership of those objectives and strengthen their commitment to meet them.

← 22. A debt standstill scheme going beyond the bilateral debt relief agreement of G20 countries is proposed by Bolton et al. (2020). For each participating country, the proposal involves the creation of a central credit facility managed and monitored by a multilateral institution, which collects interest payments to all bilateral and private lenders to use these funds in COVID-19 relief. It is estimated that such a standstill could spare USD 800 billion for emerging-market economies and developing countries, representing close to 5% of their annual GDP.

← 23. Domestic financial conditions in emerging-market economies operating with flexible exchange rates seem to be less prone to respond to global financial conditions than those in emerging-market economies with exchange rate pegs (Obstfeld et al., 2017).

← 24. Capital inflow regulations have already been eased in Argentina, China and India; and foreign-currency reserve requirements have already been lowered in Indonesia and Turkey (OECD, 2020l).

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