Economic Outlook and Policy Responses to the Coronavirus

The Economic Shock from Falling Demand Caused by Social Isolation Is Growing

Urgent Need for Government-Level Measures to Prevent Excessive Panic

Need for Coordinated Fiscal and Monetary Policy Among G7 Countries to Stimulate the Economy

As the coronavirus spreads, social distancing is becoming routine, and there is growing concern over a rapid decline in most economic activity.

Internationally, stock markets in major countries have plunged, and growth forecasts are also being revised downward. The OECD lowered its 2020 global growth forecast to 2.4%, down 0.3 percentage points from its previous estimate, and cut Korea’s growth forecast from 2.3% to 2.0%. Furthermore, there are projections that if the coronavirus becomes a global pandemic, world economic growth could plunge to the 1% range.

In general, the economic shock caused by an infectious disease outbreak such as the coronavirus can be divided into supply-side shocks and demand-side shocks. Supply-side shocks can be further divided into a decline in labor supply and a reduction in the supply of raw materials and parts due to shrinking international trade. The decline in labor supply may take three forms: work stoppages due to infection, deaths, and work stoppages intended to minimize the risk of infection. Demand-side shocks may appear as a decline in international demand, while at the same time domestic demand may fall as household income declines due to reduced labor supply and as social distancing aimed at avoiding infection suppresses domestic demand.

In the case of the MERS outbreak, which is regarded as having caused a considerable economic shock, the impact under the above classification was limited to a decline in domestic demand caused by social distancing to avoid infection.

However, the current coronavirus crisis is spreading internationally, while domestic social isolation is also intensifying seriously, raising concern that both the supply side and the demand side will suffer shocks far greater than those seen during MERS. The MERS outbreak lowered Korea’s economic growth rate by as much as 0.3 percentage points, but the impact of the current coronavirus on growth will be much larger. Accordingly, it can be projected that Korea’s economic growth in 2020 will remain in the 1% range.

The question is when the spread of the coronavirus will begin to subside. The sooner that point arrives, the more the economic shock can be contained. However, historical experience suggests that even when the spread of an infectious disease begins to ease, the resulting demand and supply shocks tend to persist for at least two quarters. Therefore, it goes without saying that the most urgent task is to maximize quarantine and prevention efforts to block infections and curb the spread.

Comparing shocks on the demand side and the supply side, demand shocks are generally much larger. This is because the economic shock from falling demand caused by social isolation is far greater than the decline in labor supply caused by infection and death. In the case of the current coronavirus, the infection rate and fatality rate do not appear large enough to affect labor supply significantly, and even if they do, most of the effect is likely to come from work stoppages intended to avoid infection. Therefore, most of the economic shock arising from domestic factors will stem from social isolation aimed at avoiding infection. Of course, when the number of confirmed cases is rising by hundreds per day, social distancing cannot be restrained. But once the spread begins to subside, it will be necessary to prevent further expansion of social isolation. There is an urgent need for government-level measures to prevent the entire country from falling into excessive panic and to limit the expansion of social isolation.

As for the decline in international demand, the first priority must be active cooperation in international coordination to prevent the spread of the coronavirus. In addition, it is necessary to participate in the coordinated fiscal and monetary policy response for economic stimulus currently being discussed mainly among the G7 countries. In responding to the unprecedented economic shock caused by the coronavirus, increasing fiscal spending is unavoidable in some respects. However, to prevent this from leading to wasteful and inefficient spending, expenditures should be concentrated in areas where they are truly needed, such as the medical sector for quarantine and disease control, as well as affected industries and small business owners.

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Original title: 코로나 바이러스의 경제적 영향 전망과 대책

Author: Won-geun Song

Date: 2020-03-06

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=press&pn=22&idx=22453