Global economy hit by severest shock since 1930s

LONDON: Recessions often start with a small drop in activity which then progressively deepens over subsequent months as the second and higher-round effects on the economy start to occur.

But the current business cycle downturn looks very different. In terms of its scale and sudden onset, there is no parallel since the end of the Second World War. The initial shock from the coronavirus outbreak and the shutdown of much of the transportation and business system is both large and sudden.

There are no government statistics yet on the scale of the current downturn, but taking the oil industry as a proxy for economic demand, consumption appears to have fallen by around 10 million barrels per day, or 10 percent, within the space of a single month. The first-round shock to the system is enormous even before any second and third-round impact on business and consumer spending. In 1945, demobilization and the conversion from wartime to peacetime production caused industrial output to drop by 30-35 percent progressively over 12 months.

In the 1974/75 recession, US industrial output fell by around 15 percent over roughly 20 months, according to data from the Federal Reserve.

In 2008/09, US industrial output declined by almost 20 percent from its pre-recession peak, but the decline was stretched over a period of roughly 18 months. All these magnitudes and durations are approximate because peaks and troughs in industrial production do not correspond precisely with the official business cycle dates, which take into account other factors as well.

But the current downturn could easily prove the steepest since 1945. In scale and sudden onset, it looks more like the dynamics of the 1930s Depression or the violent business busts of the late 19th and early 20th centuries.

Initial shock

Recessions can be a lot like epidemics in that a small initial disturbance-the infection of a single patient or failure of a single business/sectorgrows exponentially as it is transmitted through the rest of the system. In recent years, economists have drawn on research from epidemiology to understand how a single bank or business failure can set off a cascading failure as it spreads across the economy.

The initial infection or business failure may be relatively inconsequential; it is the network of connections by which it is transmitted across the population or the economy that turns an isolated problem into a pandemic or recession. In the case of the economy, recessions are transmitted through real changes in the flow of spending and income, namely sales, orders, employment, wages and debt payments. But transmission can be accelerated by changes in the stories individuals and businesses construct about the immediate future and the impact on their decision-making. — Reuters