The Corona Crisis – a Scandinavian perspective.

Today Swedish journalist Nathalie Besèr and I have had a talk about the economic and political perspectives on the corona crisis from a Scandinavian perspective.

We among other things talk about the different policies in the Scandinavian countries and look at the economic consequences of the crisis.

ONE factor explains most of the differences in Covid19 deaths across countries

As an economist I am not happy about going into having strong views on the causes of why people die from Covid19, but at least I can have a look at correlations.

It has been very clear for some time that very few people younger than 50 years old die from Covid19.

In fact the average of people dying with Covid19 have been around 80 years in most countries and men are more likely to die than women.

These simple facts made me think – how much of this can explain the different mortality rates we observe across countries?

Why has so many people died in Italy and Spain, while mortality rates have been much lower in for example Scandinavia? Similarly why are mortality rates so low in most developing countries?

Can the age composition explain this? The graph below give us the answer.

Covid19 deaths POP

In the graph I have plotted the number of deads with Covid19 per 1 million population versus the share of the male population older than 80 years (%).

The data was collected on Friday April 17 2020 and I have only looked at countries with at least 100 deaths from Covid19 and excluded very small countries like Andorra.

As we see there is a very strong correlation between the two and it is certainly strong enough for me to argue that the absolut most important variable determining whether or not a country will be hard hit or not by the Covid19 crisis is the the age structure in the country.

Countries with a lot of old men will simply suffer a lot bigger blow than countries with younger populations.

It should of course be noted that I here compare countries, which are in different phases of the Covid19 crisis.

Correcting for that might make the “model” more (or less?) precise and we could of course also add more variables – for example air pollution, which think also is an important factor, but what is notable is that age alone is such an important factor.

From that perspective it also seem amazing to me that countries have introduced more or less draconian curfews and lockdowns around the world basically for everybody rather than focusing on protecting the most fragile parts of the population – the elderly.

In fact, if we look at Sweden which have likely has the most liberal approach to combating the Covid19 we see that Sweden’s mortality rate overall is not much different from other countries and if we put a regression line in the graph then Sweden would be more or less smack on that regression line.

Two nations to worry about – Greece and Japan

When looking at the graph it is very clear that two countries are clear outlier – Greece and Japan. Both countries have a quite high share of males older than 80 years (both above 6% – and higher than in Italy).

However, unlike Italy or Spain both Greece and Japan so far have avoided a large number of deaths. The question is why?

I don’t have a clear cut answer, but the Greek government early on put the entire nation on a very strict curfew – essentially locking up the Greek population in their own home.

The Japanese approach has been very different, but at least so far a major Covid19 outbreak have been avoided.

The question is, however, this will remain the case?

It is pretty clear that sooner or later Greek government will have to open up society and at that point there obviously is a risk of a Covid19-Tsunami hitting the country. Greece in that sense seems stuck between a rock and a hard place. Either the country goes bankrupt or the number of Covid19 death will likely increase sharply.

Japan has had a much less draconian approach than Greece or Spain and Italy for that matter and despite of that Japan has been able to avoid the Covid19 Tsunami. So maybe Japan’s approach should be copied by other countries – or maybe Japan so far has just been lucky. I don’t the answer to this.

The purpose of this post is to highlight the very clear relationship between share of the male population older than 80 years and the mortality across countries, but I must say that developments over the past week or so in terms of people being infected with Covid19 in Japan and the number of deaths and my fear clearly is that Japan could catch up with the “pattern” in the rest of the world. I certainly hope that that will not happen.

All set for a fast recovery after the ‘Great Lockdown’

In 2005, Hurricane Katrina hit New Orleans in the US state of Louisiana. The hurricane caused enormous material destruction and about 2,000 people perished.

While Katrina obviously cannot be compared to Covid19 in terms material devastation and death it nonetheless is comparable in terms of the sudden the “shutdown” of the economy.

Katrina was a very clear case of a supply shock. Production facilities were simply shut down. And in the same way as today, it happened from one day to the next.

But nothing really had happened to the fundamentals of the economy – this to a large extent is also the case in terms of the Covid19 around the world.

Katrina was a huge, but very short-lived economic shock

If we look at how things were going for Louisiana’s economy in 2005-6, then you will see that in economic terms, it was a huge negative shock, but the shock was also very short-lived.

We can see that by looking at various indicators of the labor market.

Recently, there has been a lot of focus on US initial jobless claims figures, which have spiked in recent weeks and US unemployment is like to soon hit double digit-figures. This clearly is deeply worrying, but if we look at what we saw in Louisiana in 2005 it might be that we should be less concerned for the longer-term consequences.

When the shock (the hurricane) hit, there was a strong spike in initial claims that is very similar to what we have seen recently – both in speed and scale.

But as the graph below shows, it was a very short-lived shock, and after a few weeks, claims began to subside, and after 3-4 months we were back to normal.

Katrina 1

In this context, we must keep in mind that there was enormous material damage in New Orleans, which greatly affected production in the area affected by the hurricane.

There is no material damage to Covid19. When the lockdowns around the world comes to an end, production can be re-started immediately. Yes, there will of course be a prolonged shock to relative demand for e.g. restaurants and air travel, but it does not change the overall nominal demand in the economy – only the composition of demand. And remember here – nominal demand in the economy is essentially determined by the demand and supply for money. More on that below.

If we look at unemployment in New Orleans, we see that unemployment from one month to another (August to September 2005) rose to more than 15% (more or less what is expected in the US now). But it was a very short-lived shock. 4-5 months later, unemployment had fallen back to the pre-shock level. A similar picture can also be found in employment.

These figures should make you optimistic that the shutdown shock will generally have a very short-term effect on economic activity in the United States – and in the world in general.

So yes, US unemployment is rising sharply right now, but if the lesson from Katrina tells us something, then we should not be surprised if unemployment has dropped back to levels not far from pre-corona levels when Americans vote at the US presidential elections in November.

Katrina 2

That being said, there is a loss of production and activity in the economy, no matter what, it will take time to recover. So, if we look at the economic activity in Louisiana, it took just over a year to get back to “normal”.

But again, it must be remembered that there was very extensive material damage that made production difficult for many months. We do not have that challenge today.

Therefore, when some claim that it will “take years” to get through the Lockdown crisis, I actually think we have to be a lot more optimistic.

Katrina 3

The Corona shock is primarily a lockdown shock to the economy – in the same way as Katrina was in Louisiana in 2005. And as soon as we move out of the lockdowns around world economic activity very will quickly pickup and return to pre-crisis levels.

Market economies – when allowed to – adjust very clearly to supply shocks – whether it is a hurricane or a pandemic.

It looks like we will avoid a major demand shock

It should, however, be remembered that for the price system to work well so the economy swiftly adjusts to changes in relative prices (as demand in certain sector maybe more permanently drops – for example tourism, restaurants and major sports events) it is necessary that nominal demand is kept on track. It is primary a task for central banks to ensure this.

I must, however, admit that I was very worried about this in the beginning of this crisis, as inflation expectations (in the bond markets) dropped very sharply both in the US and the euro zone and that financial distress increased sharply.

Fortunately, however, the Federal Reserve (and partly also the ECB) was quick to respond and although US inflation expectations are still a little too low (way below Fed’s 2% inflation target), the situation has largely stabilized.

Katrina 4

At the same time, major fiscal easing has been adopted in both the US and Europe. So, the risk of a negative demand shock in my opinion now is quite small.

The risk of premature monetary tightening is still there but I believe the risk of that is substantially lower today than in aftermath of the 2008 shock.

Say Law’s and the Fed will ensure a swift recovery

The IMF has dubbed this crisis the Great Lockdown. I think this very well captures the nature of this crisis. It’s primarily a negative supply shock, which at some point also partly looked to developed into a demand shock.

One could illustrate this in a simple AS-AD framework, but I actually think it more fitting to think of this as Say’s Law in action.

John Maynard Keynes formulated Say’s Law to mean that “supply creates its own demand”. Or rather production creates demand.

The Great Lockdown happened because households around the world more or less simultaneously decided to redraw from the labour market – either because of their own voluntary actions or because of government curfews or a combination of these.

In that sense on can also think of this as the first global Real Business Cycle (RBC) recession. But there has always been one problem with RBC models – it is hard to generate year-long recessions in these kinds of models. Recessions are not a result of people of going on vacation – except this time it is actually is. This is an unplanned and partly involuntary “vacation”.

But one can actually question whether this is a recession in the way we normally think about it. Nick Rowe has defined a recession as a situation where there is a general glut (excess supply) of newly-produced goods.

A negative demand shock creates such a general glut, but that is not the case with a negative supply shock – and it not the case with the Great Lockdown.

In the Great Lockdown the problem is not general lack of demand, but lack of production. Changes in relative demand also create problem for certain sector (air travel, restaurants, sport events etc.), but that is not the reason for the crisis – specific sectoral problems is no the reason for the overall decline in economic activity.

Therefore, once we emerge from the “lockdown” phase production­ will pick-up fast and then Say’s Law will take care of demand.

However, as uncertainty might remain heightened for a longer period, we should not rule out that there also will remain a heightened demand for money and safe assets. This could cause money-velocity to decline and push down nominal demand growth.

To avoid this, it is the task of central banks to offset this velocity shock by expanding the money base. Luckily the Federal Reserve seems to have gotten the message and has responded well during this crisis and so far, have succeed in stabilizing market inflation expectations.

The Fed has not done a perfect job, but certainly good enough in my view to ensure that this is not about to turn into a major negative demand shock.

So, in conclusion as long as the Fed keeps nominal demand on track and keep inflation expectations stable then we should expect that Say’s Law will ensure a fast recovery in the US economy (and likely the world economy).

As Hurricane Katrina shows us natural disasters can hit an economy very hard and send economic activity down very sharply and unemployment up extremely quickly, but economic activity also returns fairly quickly.

The imitate contraction in GDP in most countries in the world during this crisis is likely to be larger than during the Great Recession in 2008-9, but duration of the crisis is likely be much shorter – likely months rather than years.

So, let me stick my neck out and give you a forecast on US unemployment – unemployment will rise sharply in April maybe above 15% and is likely to remain elevated in June and July, thereafter unemployment will drop fast and will likely be back to the ‘structural’ level around 5-6% in November. The only conditions I have for this forecast is that the Fed ensures that market inflation expectations does not drop below present levels.

PS I believe that we could best understand the Great Recession by reading Milton Friedman, but to we should rather read F. A. Hayek to understand the mechanism in play during the Great Lockdown – that goes both for his warnings against totalitarianism (“Road to Selfdom“), his opposition to economic planning (The Socialist-calculation debate) and his deep understanding of the The Price System as a Mechanism for Using Knowledge.  2008 was primarily about monetary policy failure – today’s crisis is mostly about regulatory overkill.

A talk with the Icelandic Minister of Finance on the corona crisis

Everyday at 1000 CET I do a Facebook Live Update on the economic and financial consequences of the corona shock.

It is normally in Danish but today I did it in English because I had invited the Icelandic Minister of Finance Bjarni Benediktsson to join me for a talk about Iceland’s response to the corona shock.

You can watch the talk here and you can follow me on Facebook here.

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