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Covid-19: A very different economic downturn

The current economic downturn has been triggered by a deliberate lockdown and not by imbalances in the system. Economic activity should drop lower than at any time during the past 75 years and then recover fast by historical standards.

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The economic downturn caused by measures to contain the spreading of Covid-19 is very different from past recessions, as it has been caused by a deliberate lockdown and not by imbalances in the economic or financial system. 

First business climate economic indicators for April, which cover the period when lockdowns were already in full force, highlight the very special shape of the economic slump. Otherwise resilient sectors (e.g. large parts of the services sector) are driving activity down, while the cyclical parts of the economy (e.g. manufacturing and construction) appear more robust. 

April flash PMIs for the US, Europe and Japan showed much lower levels for services than for manufacturing, and German ifo business climate surveys for April reveal the same pattern, with manufacturing and construction being much more resilient than services and retail. 

The corollary of the very special cause of the downturn is a much deeper and faster drop in economic activity than at any time in the past 75 years. At the same time, the potential for a quick recovery is large, making the downturn short in a historical context. 

In the US, the share of cyclical spending has been much lower than ahead of past recessions, and the same holds true for credit leverage. Against this backdrop, sharply rising unemployment, with 26.5 million initial jobless claims in the US in the last five weeks, is hardly a sign of labour market weakness but rather a measure of the efficiency of fiscal support. The same holds true for assessing the sharp increase in the number of short-time workers that Germany and other European countries are expected to report. 

The increasingly coordinated fiscal and monetary policy response also argues for a swift recovery once the health crisis abates. The Bank of Japan strengthened its commitment at its latest meeting to allow more fiscal support by committing to unlimited buying of government bonds. The European Central Bank and the US Federal Reserve will have the opportunity later this week to show their commitment to monetary-fiscal policy coordination.