ECONOMIC IMPACTS OF COVID-19 (U.S ECONOMY)

Abstract

The following essay portrays the adverse effects of COVID-19 on global level, giving greater focus to its effects on the US economy. It throws light on the various sectors and aspects of GDP and how they were affected by the rise of this virus. It also explains the monetary policy actions adopted by the Federal Reserve to combat the ongoing crisis and links it with the IS-LM framework. 

A Brief History and Global Outlook

 

China alerted the World Health Organisation about few unusual pneumonia cases in Wuhan on December 31^st. It was later understood that it was happening due to the rise of a new virus named COVID-19. The World Health Organisation(WHO) first declared COVID-19 a world health emergency in January 2020. From march, the epicentre shifted from China to central Europe and the United States. Since then  the virus has evolved into a global pandemic affecting public health and economies of almost 200 countries. The virus’s impact on the $90 trillion economy is beyond anything experienced in over a century. No country was lucky enough to be spared by the ill effects of the COVID-19 and so faced a huge decline in economic growth as well as government revenue. The global lockdown had a significant impact on world economy as a whole. Restaurants, pubs, factories, flights, colleges etc. were shut down and fear of the virus led to a minimal movement among individuals. Consumers not buying commodities was affecting the economy severely. According to OECD (Organization for Economic Co-operation and Development) data, the global economic growth might expect a fall from 2.9% to 1.5% or it might fall even further.    

Economic Impacts of COVID-19

 

Impact on GDP

 

COVID-19 has had a vast number of economic impacts on the US economy. The US Bureau of Economic Analysis reported a fall of 4.8% in the first quarter of 2020 on annualized basis. This decline is one of the biggest in GDP numbers and the worst quarterly contraction since the great recession in 2008-09. As per few forecasters, the following quarters are going to be substantially worse as the first quarter fall does not completely capture the economic carnage brought upon by the pandemic on the US economy. The prominent factors for this decline were the fall in

• Personal Consumption Expenditure(PCE), which is  largest contributor to the economy with a total share of around 70% in the GDP. The fall in PCE of 7.6 % during Q1 of 2020 was highest recorded fall in its history having the biggest impact on the economy.
•  Gross Private Investment (Capital expenditure on machinery, buildings etc.), with a contribution of 17% in GDP.
•  Net Exports, around 4% contribution in GDP.
• Government Consumption Expenditure, around 18% contribution in GDP

Impact on Unemployment

Another major impact of the virus was on unemployment. The unemployment rates have   skyrocketed since the arrival of this virus. As the following graph shows, United Sates was worst affected by unemployment.

Many people have either lost their jobs or have seen a reduction in income. Sectors like tourism and hospitality were the worst affected as these sectors came to a literal standstill under lockdown. According to the IMF, the proportion of people out of work hit a staggering 10.4% in the United States putting an end to a decade of expansion in its economy. Other major economies like Germany, United Kingdom, France, and Italy shared the same fate.

Impact on Supply Chain

Along with fall in GDP, COVID-19 disrupted the supply chain globally. Global trade in 2020 is expected to fall in almost every region affecting each sector of the economy. This fall in trade will be not just be a huge blow for the exporting giants but also for those countries who rely heavily on imports. The World Trade Organization(WTO) estimates global trade to fall up to 32% in 2020 due to the pandemic. Naturally US economy also suffered huge losses due to this disruption. 

 

Apart from the above mentioned impacts, the virus has also affected the oil market quiet severely as oil rates in general witnessed a significant fall. As people stopped steeping out of their houses or using their vehicles, there was a massive fall in the demand of oil thus having a negative impact on its prices.  

Monetary Policy Actions

The rise in cases associated with business closures and restrictions on an individual’s movements have triggered an economic slowdown for an uncertain duration. This has called for an intervention in the form of either monetary or fiscal policy actions. The Federal Reserve has decided to step in with a number of actions to limit the damage caused from the pandemic, including an approximate $2.3 trillion in lending to support households, financial markets, employers etc. Few of the main monetary policy actions are mentioned below. 

•   Federal funds rate : It is the rate banks are supposed to pay to borrow from each other. The fed has decided to cut its targets by a 1.5 percentage points since the beginning of march 2020 bringing the federal funds rate down to a range of 0 to 0.25 percent (near zero rates). This rate acts as a benchmark for other short-term rates while also affecting long-term rates. This action is aimed at lowering the cost of borrowing on home equity loans, mortgages etc. 

•  Security Purchases : A key tool used during the time of the Great Recession was the purchase of securities when the federal reserve bought trillions of long-term securities. The federal reserve has yet again started purchasing huge amounts of securities. The mortgage-backed securities market and the treasury securities market have become dysfunctional since the outbreak of the virus and so the Fed’s actions are targeted towards restoring the smooth functioning of the market to ensure that credit continues to flow. In mid-march, the federal reserve agreed to buy $200 billion in mortgage-backed securities and $500 billion in treasury securities. 

•  Repo operations : Repo markets are the ones where firms decide to lend or borrow cash securities for short term basis. The federal reserve has immensely expanded the scope of its (repo) operations for channelling cash to money markets. Disruptions in these markets affect the federal funds rate which is the fed’s primary tool for attaining price stability. The fed’s actions help in making cash available to the primary dealers in exchange of government-backed mortgage securities or treasury securities. 

 

Through its monetary policies, the federal reserve is trying its best to make sure that the credit continues to flow in the market to aid households and business during difficult times. The fed in its policies has given a lot of focus to the capital markets due to the fact that in the United States, a lot of credit flows through these markets. The treasury market lays the foundation for trading in many other securities markets, a disruption in it will impair the functioning of many other markets. So the fed attempts to ensure smooth functioning of this market. It should also be noted that equal importance is being given on bringing down the interest rate encouraging banks to lend at lower rates.

IS-LM Framework 

Also known as the Hicks-Hansen model, the IS-LM model was developed in 1937. The model consists of two curves namely IS and LM curves with GDP(Y) being placed on the horizontal axis and the interest rates(R) on the vertical axis. The IS curve represents  the levels output and interest rates at which total savings(S) in the economy becomes equal to total investment(I). While the LM curve represents the levels of interest rate and output at which the money demand becomes equal to the money supply in the economy. The IS curve is downward sloping since at lower levels of interest, investments are high which lead to an increase in output. The LM curve on the contrary is upward sloping due to the fact that higher levels of GDP(income) induces consumers to hold more money which in general requires higher levels to interest rates to keep money demand and supply in equilibrium. It is also important to understand that fiscal policy changes lead to a movement or shift of the IS curve while monetary policy changes lead to a movement or shift of the LM curve. The intersection of these two curves determines equilibrium interest and output in the economy.

As we witnessed in the US economy, the federal reserve resorted to aggressive expansionary monetary policies like massive reductions in interest rates to increase the overall output in the economy. 

The expansionary monetary policy of fall in interest rates led to a rightward shift of the LM curve from point LM0 to point LM1 increasing the income of the consumers from point Y0 to Y1 and bringing the equilibrium rate down to point E1 from point E0. We can also observe that since this was a monetary policy action, a change could be seen only in the LM curve which is directly affected by monetary policy actions and no change was observed in the  IS curve. It is also important to understand that one way for reducing interest rates is by increasing the money supply in the economy. However, the fed needs to be very careful while doing so as this increase in money supply will lead to higher levels of inflation in the economy leading to an inward shift of IS curve which in turn increases the interest rates and causes an economic slowdown. 

CONCLUSION

In its wake, COVID-19 has brought a health hazard leading to an economic turmoil on the global economy. As the number of cases rise in the US, the chances of recovery slims down even further. With a massive decrease in the propensity to spend by the consumers, the economy starts to fall. Thus to tackle the current economic crisis, governments all across the world are announcing packages of billions of dollars to improve their economic condition and protect their citizens from poverty. The US government itself has announced $2.2 trillion COVID relief package for distribution to eligible citizens. At this point, a global recession seems inevitable. Without a quick solution for the pandemic, the economic crisis may last longer than the forecasted period.  

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