Perspectives

A new, massive shock

EcoPerspectives // 2nd quarter 2020  
8
economic-research.bnpparibas.com  
Eurozone  
A new, massive shock  
The Covid-19 pandemic has triggered a recession in the Eurozone that looks likely to be deep but short-lived. After a difficult year and  
a half on the economic front, the Eurozone was showing some resilience and was even beginning to show signs of stabilisation. The  
current shock  in demand, supply and uncertainty simultaneously  has completely changed the outlook. The health measures  
taken- which have been necessary to protect the population from the virus- have created the conditions for a recession. Monetary and  
fiscal policymakers have reacted swiftly and, so far, proportionately. However, the profile of the economic recovery remains unclear  
and will be crucial in assessing the damage ultimately caused by the pandemic.  
Completed on 7 April 2020 Forecasts: last update on 9 April 2020  
1
- GDP Growth and inflation  
Just three months ago we, along with many other observers, were  
expecting the beginning of an economic stabilisation. Both the  
global and Eurozone economies had managed to come through  
many challenges and imbalances, such as the significant rise in  
tensions in international trade, the marked slowdown in China and  
the difficulties of the manufacturing sector and stretched valuations  
in certain markets. However none of these factors had proved  
sufficient to send the global economy into recession. Clearly, the  
picture today is different. The Covid-19 pandemic has created a  
massive shock, which will push the Eurozone economy into  
recession this year.  
(
Y/Y, %)  
GDP Growth  
Forecast  
Inflation  
Forecast  
1
0
8
6
4
2
0
2
4
6
8
0.8  
1.9  
1.8  
1.2  
1.2  
1.2  
0.2  
-
-
-
-
A three-pronged shock: supply, demand, uncertainty  
-
10  
-8.3  
2
018  
2019  
2020  
2021  
2018  
2019  
2020  
2021  
Until recently, the available economic indicators that we usually  
monitor only partially reflected the shock. At that stage, the Covid-19  
was seen as a uniquely Chinese - and thus fairly distant-  
phenomenon. The expectations of economic agents in the Eurozone  
did not deteriorate immediately, and the same was true in the US  
economy, where the standard deviations of forecasts is still high,  
reflecting the considerable uncertainty surrounding possible  
Source: BNP Paribas Global Markets  
2
- PMI index in Eurozone  
6
5
0
Manufacturing  
Services  
6
1
55  
50  
economic scenarios . The publication of the Purchasing Managers  
Index (PMI) figures for March has changed the picture. The  
composite PMI fell from 51.6 in February to 31.4 in March. This  
collapse was largely due to the abrupt fall in the service sector PMI,  
which hit a record low of 28.4. The previous low point, dating back  
to February 2009, saw the service sector PMI drop to 39.2,  
highlighting the scale of the current shock. These figures confirm the  
4
4
3
5
0
5
30  
2
real-time data .  
2
5
0
0
02  
04  
06  
08  
10  
12  
14  
16  
18  
20  
The Covid-19 is a triple shock for the economy. First there is a  
supply shock, seen in the forced closure of factories and a shortage  
of workers, who no longer go to their workplaces. Other production  
facilities are hit by the shortage of intermediate goods flowing from  
upstream, and scale back business volumes in response. Then  
there is a demand shock, coming from consumers. The confinement  
measures taken in various European countries and the closure of  
many shops automatically hit consumer spending. Finally, there are  
still many uncertainties, notably regarding the duration of  
confinement measures, the strength of pent-up demand and the  
Source: Markit  
effectiveness of economic stimulus policies (see below). These  
uncertainties will hold back company investment and lead to a build-  
up in precautionary savings.  
3
According to the OECD’s initial evaluation , the impact on Eurozone  
countries is likely to be temporary but strong. The initial shock of the  
health measures will lead to an overall loss of economic activity, in  
real terms, of between 25% and 30% in the largest European  
economies (relative to a normal situation). Given the nature of the  
composition of the different economies the impact will be greater in  
the transport sector in Germany than in France for example.  
1
A. Dietrich et al., News and uncertainty about the economic fallout of  
COVID-19: Survey evidence and implications for monetary policy, VOX  
CEPR, 24 March 2020  
Real-time data show virus hit to global economic activity, Financial Times,  
2
3
Evaluating the initial impact of Covid containment measures on activity,  
22 March 2020  
OECD, March 2020  
EcoPerspectives // 2nd quarter 2020  
9
economic-research.bnpparibas.com  
Considerable uncertainty remains, however, and several factors  
could accentuate or attenuate the initial effect. This will depend on  
the duration of confinement measures and the possible tightening of  
the lockdown in the short term, and the extent to which the lost  
ground can be regained in the medium term. For example, lost  
spending in “restaurants and hotels” and “leisure services”, which  
together account for 12% of total consumer spending in the  
Eurozone, cannot be regained. It would therefore be a dead loss.  
Conversely, spending on “clothes and shoes” is at least partially  
redeemable, either through the substitution of online purchases or  
increased spending once shops re-open. This sector accounts for  
nearly 5% of total consumer spending. In addition, the ‘forced’  
savings built up by consumers during confinement could provide a  
strong base for a vigorous recovery (particularly as oil prices have  
fallen significantly, thus helping boost purchasing power). However,  
the return to normal patterns of consumer spending will depend on  
consumer confidence in the Eurozone. If the deterioration in  
confidence seen in March (The European Commission consumer  
confidence index fell to -11.6, the lowest figure since the end of  
allowed to deviate from the nominal deficit target of 3% or from  
imposed structural adjustments.  
Fiscal support has once again been facilitated by the monetary  
policy adopted by the European Central Bank (ECB). The ECB has  
announced massive and flexible measures to respond to the  
economic effects of the Covid-19 pandemic. At the monetary policy  
meeting on 12 March, Christine Lagarde had already introduced  
several support measures, and in particular the creation of an  
additional budget of EUR 120 bn between now and the end of 2020  
(
in addition to the existing asset purchase programme). A further  
emergency programme was announced on 18 March. Worth a total  
of EUR 750 bn, the temporary Pandemic Emergency Purchases  
Programme (PEPP) is likely to last until the end of 2020 and will  
limit the risk of a tightening of financial conditions and of  
fragmentation within the Eurozone. In a new development, the  
existing asset purchase limits in the initial asset purchase  
programme will not apply to the emergency programme, giving it  
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much greater flexibility . In addition, the PEPP will target short-dated  
assets, thus increasing the response to liquidity issues. Assuming  
net monthly purchases of EUR20 billion, a total of EUR 1000 bn in  
assets will be purchased by the ECB in 2020, or nearly 10% of  
Eurozone GDP.  
2014) continues, then precautionary behaviours could limit the  
recovery.  
The key challenge for public policy: ensuring the  
best conditions for a robust recovery  
In the medium term, the effects of the Covid-19 pandemic will have  
a lasting downward effect on the real natural interest rate in the  
The health measures taken in the Eurozone have an inevitable and  
immediate effect on growth. Economic policy will then have a role to  
play to ensure the conditions for a vigorous recovery. Short-term  
measures to avoid a shortage of liquidity will need to be backed up  
with measures to limit the threat to the solvency of many companies.  
The measures taken so far look logical given the experience of  
previous crises. The introduction of short-time working facilities and  
cash flow support for companies (through government guarantees  
on loans or deferred-payment deadlines for tax and social security  
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Eurozone , which is already close to zero, if not negative.  
Investment will be reduced. Conversely, discretionary savings will  
be increased, either due to a more cautious approach or simply  
because people will seek to rebuild the capital lost during the  
epidemic phase.  
In summary, this crisis poses many questions. It has forced  
monetary policy to go further in the use of non-conventional tools.  
What might the next step be? The possibility of a direct distribution  
of cash to economic agents is already being discussed, but raises  
significant questions, particularly from a democratic point of view.  
For governments, the support made necessary by the crisis, and the  
expected collapse in economic activity, will increase government  
deficits and debt. Will this be followed by fiscal consolidation? Will  
the crisis accelerate the Japanisation of the Eurozone? We will  
return to all these questions once the health and the economic  
emergencies have been dealt with.  
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costs) would therefore look like sensible moves , and indeed have  
been adopted in several countries. These actions should mitigate  
the impact of the crisis on employment and productive capacities.  
That said, the scale of the Covid-19 shock and the extent of health  
measures taken vary from one country to another, as do the fiscal  
responses. Thus the discretionary fiscal stimulus (excluding loan  
guarantees and payment deferrals) is currently much greater in  
5
Germany than in France, Italy or Spain . At the European level,  
some decisions have been taken, although this remains relatively  
limited and no consensus has emerged on a common fiscal tool  
(
such as Coronabonds). Most notably, the Commission has  
triggered the “general escape clause” due to the shock being both  
6
exceptional in nature and out of the control of governments . This  
clause allows member states derogation from public finance targets,  
through a suspension of the rules. In other terms, countries are now  
4
G. Gopinath, Limiting the economic fallout of the Coronavirus with large  
targeted policies, IMF Blog 9 March 2020  
J. Anderson et al., The fiscal response to the economic fallout from the  
5
7
Decision (EU) 2020/440 of the European Central Bank of 24 March 2020  
coronavirus, Bruegel, 27 March 2020  
Coronavirus: Commission proposes to activate fiscal framework’s general  
on the temporary PEPP (ECB/2020/17)  
O. Jordà et al, Longer-run economic consequences of pandemics, Federal  
6
8
escape clause, European Commission, 20 March 2020  
Reserve Bank of San Francisco, March 2020  
QUI SOMMES-NOUS ? Trois équipes d'économistes (économies OCDE, économies émergentes et risque pays, économie bancaire) forment la Direction des Etudes Economiques de BNP Paribas.
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