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Coronavirus 16 Apr 2020

From the Great Recession to the Great Pandemic: the differences between the 2008 and 2020 crises

Although the consequences may be similar, there are significant differences between the economic recession of 2008 and the crisis that has abruptly erupted in 2020, primarily their origins: the Great Recession of 2008 was systemic and first took hold in the financial system; the Great Pandemic of 2020 is a cyclical crisis caused because the economy was brought to a sudden standstill in response to a health crisis. While there is a lot of uncertainty about the outcome, experts say that the rate of recovery depends on the speed with which containment measures are lifted.

“The 2008 and 2020 crises have totally different origins,” says Enrique Marazuela, Director of Investments at BBVA Private Banking. “The former was a financial crisis; unsustainable levels of debt had been taken on at a time when there was also a lack of credit quality for many assets that were not totally familiar to many in the investing public. This caused the financial system to collapse with the systemic consequences of which we are all too aware.”

The crisis that started with Lehman Brothers’ bankruptcy sparked mistrust across the entire financial system worldwide. According to Rafael Doménech, Head of Economic Analysis at BBVA Research and Professor at the University of Valencia, the 2008 crisis was caused by a variety of imbalances that accumulated at the same time in a number of economies, as a result of a real estate and financing bubble. At the same time there was an increased level of business and household debt and excessive leveraging of a considerable portion of the financial system. “When these imbalances could no longer be sustained, the economy came to a sudden stop. This caused a lot of debt-laden companies and financial institutions to go bankrupt, compounded by a lot of households having payment issues,” he points out.

 "There has not been as traumatic a global, collective experience since World War II (1939-1945)," Marazuela maintains

In contrast to the underlying financial cause of the 2008 recession, the current crisis is rooted in a health crisis that, like a natural disaster might, has caused far-reaching, unexpected economic repercussions. There is another difference with 2008, the origin of this crisis is not nebulous, rather it is concrete: the international contagion of COVID-19. In addition, for the time being, it is cyclical in nature, not systemic, and it is causing damage to both supply and demand. Still, it has been more abrupt.

2020 started off in a better position

The starting position for the 2020 economy is also different, and considerably better than 2008's. This is good news. The imbalances are less pronounced; businesses and families have less debt; and the financial system has more capital and is healthier overall.

Nevertheless, there are some similarities between the new crises. “The consequences are similar: severe damage to employment and calls for borrowing in order to cushion the impact on productive sectors and families, to the extent possible,” explains Joaquín García Huerga, Head of Global Strategy at BBVA Asset Management.

Javier Niederleytner, Professor for the Institute of Stock Exchange Studies (IEB) in the Financial Markets master’s degree program explains that in 2008, it was a demand crisis created from a lack of confidence. In contrast, “the 2020 crisis started off as a supply-side crisis: factories in China were closed due to the epidemic and that led to a lack of components for many companies in the West.” However, that was followed by a second phase. Once the pandemic had spread, a crisis of demand resulted because consumption was adversely impacted by containment measures. This in turn has led to significant unemployment, which features in both crises.” he explains.

Given the abrupt halt to worldwide economic activity in recent weeks, economists believe that 2020 could see a deeper recession than 2008, but that it will not descend into a depression. “For various reasons, both in the 2008 crisis and now, we see a strong contraction in the economy, increased uncertainty, and a significant increase in unemployment,” Rafael Doménech explains. “But on this occasion, everything points to a much more significant short-term impact. The recession caused by the Great Pandemic is going to overshadow the financial crisis’ Great Recession, and it will more closely resemble the Great Depression of the 1930s.

According to the International Monetary Fund’s latest forecasts, the global GDP could fall 3 percent in 2020, compared to a 0.1% decline in 2009. If this scenario plays out, it would be, as Doménech points out, the worst economic crisis since the 1929 Great Depression. The International Monetary Fund (IMF) forecasts an 8 percent dip in Spain’s GDP this year.

What does the recovery depend on?

Uncertainty about the depth of the crisis and the rate of its recovery continues to ride high. What are the factors that will provide more visibility on how the crisis will play out?

“The key variable is the duration of the containment measures, because these are what are directly producing economic damage, which becomes exponential with time,” stresses Joaquín García Huerga. “This factor in turn depends on the reduction of the number of new cases at ground zero.” Enrique Marazuela agrees with this assessment: "Not until the pandemic is completely eradicated, or at least until it reaches an acceptable level, will we be able to talk about economic recovery.”

A key factor in the current crisis is the strength and speed with which the authorities have acted, which should help prevent the cyclical recession from turning into a systemic or structural one. Governments are increasing public spending and launching a wide range of guarantee packages for businesses, SMEs, and the self-employed, while central banks are providing increased liquidity.

“The intervention of the central banks plays a decisive role in both scenarios,” says Javier Niederleytner. “The 2008 crisis was relatively short-lived because the Federal Reserve acted fast: it lowered interest rates from 5 percent to 0. In the current situation, although central banks have acted quickly, the impact has not been as great because the origin of the crisis is non-financial. This crisis is hardly lacking in money. What needs to be done is to orchestrate how this money can reach the sectors in need, consumers, etc. The underlying problem in 2008 was that the money wasn’t there because of overarching distrust of the financial system. Now the problem is that we don't know when the pandemic will be over.”

What form will the recovery take?

The big question facing economists now is what shape will the recovery take: Will it be V, U, or L-shaped?

“With caveats and a lot of uncertainties, a V-shaped recovery could be the most likely scenario if economic policies force the implementation of the right measures,” explains Rafael Doménech. “Caveats because the recovery will not be the same across every sector and for every business. For some it will be slower than others, and it's possible that not everyone will return to the same levels of pre-crisis economic activity given changes to consumption patterns and production restructuring, while the population is not entirely immune and there is no effective vaccine available.”

"Using our central scenario, we see a progressive economic recovery starting from the end of the second quarter. Containment measures are gradually being loosened, but controls and precautionary measures will remain in place,” he explains.

According to Enrique Marazuela, large government packages of guarantees together with an increase in public spending, and the significant liquidity that central banks are injecting with programs that are already in place should succeed in preventing the crisis from becoming systemic in nature. “The economic authorities have acted early and boldly; as a result, the current coronavirus-caused crisis will be shorter than the 2008 crisis, not only because of the response by the economic authorities but also because of this crisis’ root cause,” he points out.

In this regard, the economic measures that are put in place will be decisive in determining the shape of the recovery. “The better designed and more efficient they are, the stronger each euro spent today will be, and the greater the impact on the recovery, growth, and unemployment,” Doménech explains. With the important caveat that the recovery will not be the same for all sectors and businesses. “For some it will be slower than others, and it's possible that not everyone will return to the same levels of pre-crisis economic activity given changes to consumption patterns and production restructuring, while the population is not entirely immune and there is no effective vaccine available.”  he adds.

Although not the main scenario economists are forecasting, they do not discard an economic relapse in the coming months should there be another outbreak of the pandemic. This would result in a W-shaped recovery, although with a smaller decline in GDP during the second dip. In the most positive of scenarios, the recovery will be V-shaped with a rapid return to normality and the GDP seeing a vigorous recovery starting at the end of the second quarter of 2020. Ultimately it all depends on how the pandemic progresses and how long the world takes to return to a degree of normality.