Why 2020 is different to the 2008 global financial crisis?

Following the COVID-19 pandemic and the subsequent lockdown measures pursued by most nations, economic activity has plummeted. US jobless claims (link) and UK universal credit claims (link) have reached unprecedented levels. These claims measure how many employees lose their jobs. However, I argue below why this measure is not indicative of the length of the economic downturn. Why is this crisis different than the most recent sizeable downturn of 2008? Mainly for two reasons. Firstly, there is no credit crunch for the time being. Secondly, the target of the government expenditure is different.

Beginning with the credit conditions, as opposed to 2008, banks still lend each other and if they don’t the central banks will offer ample liquidity. Therefore, banks can continue provide credit to the economy or at least they are not forced to completely stop as in 2007-2008 following the collapse of the Lehman Brothers. The basic function of credit is to transfer income from the future to the present. Households and businesses can access credit to fund their immediate needs in cash for consumption and for investment. This means consumption and investment expenditure might slow down but not massively contract as more than a decade ago.

For consumption and investment, the nature of the pandemic makes also a big difference. We can expect firms to resume their operations as soon as the lockdown is over. Worst case scenario, they will be operating at a pace a bit slower than that before the lockdown. In 2008, firms were laying off employees because they were shutting down for good and these jobs were “destroyed”. For the unemployed to find a new job, new jobs and new firms needed to be created which takes time. Furthermore, hiring back the recently laid off workers required additional investment expenditure to create new jobs, but the unavailability of credit was delaying investment and hence the recovery. In this pandemic, most of the jobs are not destroyed completely but they are temporarily vacant. This is also why the surge in unemployment claims is not informative this time. Also, note here, that the growth predictions that are available for the rest of 2020 are heavily informed by the jobless claims and by survey expectations which focus on the short term. Finally, most of the households also anticipate their future income to recover as they expect to get their jobs back, therefore they use their credit or savings to smoothen their current consumption without cutting down their expenditure as much as in 2008.

What additionally helps sustaining household expenditure is the government stimulus packages (link). These stimulus packages in addition to the existing unemployment benefits will further assist in maintaining expenditure and jobs. This will certainly increase public debt, but the fiscal multiplier in combination with the zero interest rates will act in accelerating economic growth more than the debt growth, so the debt-to-GDP will recover in the medium term. And this is a very big difference with the fiscal expansion of 2007-2008. Public debt increased then in order to fund bailouts and recapitalizations which means that it did not have any effect in the real economy. As soon as the financial sector was stabilized there was limited room for further fiscal expansion and this prolonged and deteriorated the economic contraction.

There is however a cause for alarm and that is the Eurozone. Firstly, Europe’s weakest economies, Spain and Italy, are being hit worst and having limited room for fiscal stimulus. Because of their size, negative spill overs from these two economies will be considerable especially for the Eurozone. Secondly, Europe’s zombie banks, especially from Italy, will add further pressure. Thirdly, if Eurozone approaches these threats as it did back in 2012, then they will face another more serious debt crisis and a prolonged recession.

Regardless the problems of the Eurozone, this pandemic is much different to the 2008 global financial crisis. For the time being, there is no credit crunch, and the nature of the increased government spending has positive economic effects.