The Economic and Financial Impacts of the COVID-19 Crisis Around the World: Expect the Unexpected

By Allen N. Berger, Mustafa U. Karakaplan and Raluca A. Roman

The Economic and Financial Impacts of the COVID-19 Crisis Around the World: Expect the Unexpected provides an informed, research-based in-depth understanding of the COVID-19 crisis, its impacts on households, nonfinancial firms, banks, and financial market participants, and the effectiveness of the reactions of governments and policymakers in the United States and around the world. It provides reflections and perspectives on the social costs and benefits of various policies undertaken and a toolkit of preventive measures to deal with crises beyond the COVID-19 crisis.

Authors Allen N. Berger, Mustafa U. Karakaplan, and Raluca A. Roman apply their expertise to the research and data on the COVID-19 economic crisis as well as draw on their own rich research experience. They take a holistic approach that compares and contrasts this crisis with other economic and financial crises and assesses economic and financial behavior and government policies in the booms before crises and the aftermaths following them, as well as the crises themselves. They do all this with a keen eye on “Expecting the Unexpected future crises, and policies that might anticipate them and provide better outcomes for society.

• Serves as a compendium of available research and data on COVID-19, policies in response to the pandemic, and its effects on the real economy, banking sector, and financial markets
• Contextualizes the COVID-19 economic crisis by comparing it to two other global crises from the past: the Crash of 1929 and the Global Financial Crisis of 2007–2009
• Helps illustrate how crises that originate in financial markets and in the banking sector differ from each other as well as from the COVID-19 crisis that harmed the real economy first
• Compares the policies and outcomes of nations to the COVID-19 pandemic and assesses their costs and benefits, with potential implications for prospective future crises

• Language: English
• Publisher: Academic Press
• Release date: Sep 5, 2023
• ISBN: 9780443152733

Allen N. Berger

Allen N. Berger is H. Montague Osteen, Jr., Professor in Banking and Finance at the University of South Carolina, President of the Financial Intermediation Research Society, Senior Fellow at the Wharton Financial Institutions Center, and Fellow of the European Banking Center. He has published over 125 articles in refereed journals, including in top finance journals, Journal of Finance, Journal of Financial Economics, and top economics journals, Journal of Political Economy and American Economic Review. He is co-author of two research books and co-edited all three editions of the Oxford Handbook of Banking. He serves on nine journal editorial boards, co-edited eight special issues of research journals, and formerly edited the Journal of Money, Credit, and Banking. His research has been cited over 90,000 times, including 30 articles with over 1,000 citations each, and another 19 with over 500 citations each. He has given invited keynote addresses on five continents.

Book preview

Part I

Focus of the book and other introductory materials

Introduction

COVID-19 is a global health crisis that became a global economic crisis as well. The World Health Organization (WHO) declared the disease a pandemic on March 11, 2020. The dictionary definition of a pandemic is a disease that is prevalent over a whole country or the world. The announcement came after at least 118,000 cases and 4291 deaths in 114 countries, and about 3 months after the first disease cluster in Wuhan, China was reported on December 12, 2019. The WHO has still not downgraded COVID-19 from a pandemic to an endemic as of this writing, suggesting that the disease is not yet considered to be spreading at normal or expected levels that are stable and manageable in communities. The health and death damages differ over time and continue to change across countries. The damages are now clearly much better managed overall with the available quality vaccines and ex post health treatments, but these are still not evenly applied around the world.

The economic crisis caused by COVID-19 was spreading similarly to the disease pandemic around the world in a fast and devastating fashion in early 2020. The economic and financial impacts of the COVID-19 crisis around the world—the main part of our book title—have also significantly abated and become more manageable. These problems also persist, resist control, and the policies to deal with them are unevenly applied. The continuing intertemporal and international twists and turns are demonstrated in this book.

COVID-19 continues to cause significant damage to all three key economic segments of society—the real economy, banking sector, and financial markets—in countries around the world. We define these segments in a broadly inclusive fashion to cover as many important corners of the economic and financial systems as feasible. The real economy we consider includes activities of households and nonfinancial firms and their demand- and supply-side actions. The banking sector includes commercial banks and other financial intermediaries that provide banking services, including Digital Technology Financial Firms (DTFFs) of financial technology (FinTech), big technology (BigTech), and Decentralized finance (DeFi) that use modern technologies to provide banking services online. The financial markets we contemplate are broad-based in terms of types of markets and financial claims studied. We include as financial markets standardized exchanges, over-the-counter markets, and online marketplaces. We also include capital market mixes with banks, such as securitization and syndication, and old and new conventional market methods such as initial public offerings (IPOs) and special purpose acquisition companies (SPACs), respectively, and newer nonconventional online exchange methods such as distributed ledgers. The financial claims considered cover stocks, bonds, structured products, and cryptocurrencies and other new online assets. Our coverage of these topics tilts toward the more traditional economic and financial agents, institutions, markets, and goods and services, given the much more accumulated and reliable data and research evidence on traditional items.¹

The economic and financial data and research reveal how the COVID-19 virus shocks quickly brought about declines in real economic activity starting in 2020. These were often of unprecedented speed and magnitude and spread from country to country much as did the virus. For example, the US Centers for Disease Control (CDC) reported the first US case of the disease on January 19, 2021, the US economy was in recession by February, and the national unemployment rate had increased from 3.5% to 14.8% by April. Negative shocks to supply and demand for goods and services around the globe caused recessions and soaring unemployment as households and nonfinancial firms physically withdrew from economic activity, and governments took actions to reduce disease spread by restricting economic activity involving personal contact. These economic activity declines proceeded through financial channels to cause capital and liquidity shortfalls in the banking sector and deteriorations in asset values in financial markets, although these were mostly temporary.

Research also suggests that in many cases, subsequent damages during the crisis to the real economy, banking sector, and financial markets from COVID-19 were substantially less than were expected when the economic shocks began. The relatively modest spread of damages from the real economy to the other segments was remarkable. For example, banks set aside significant additional reserves for expected loan losses that largely did not materialize. Government policy responses to the economic and financial problems were also in some cases of unprecedented speed and magnitude. Research findings tie some of the crisis policy responses to the subsequent favorable economic and financial surprises of mitigated damages relative to expectations. The research also suggests how well private sector agents in the three economic segments behaved and the effects of their actions in dealing with the challenges brought on by the disease shocks.

In this book, we apply the conceptual framework of the boom, crisis, and aftermath cycle to economic and financial crises, including COVID-19. As discussed in the chapters below, this framework is not new and not a formal model, but is very helpful for analyzing crises and particularly useful in setting up our blueprint set of strategies for contending with future crises based on this assessment.

A key feature of the conceptual framework is the inclusion of a boom phase before the crisis, during which excessive risk-taking and other misbehavior may hasten the arrival and intensify the crisis that follows. While risk-taking excesses prior to COVID-19 did not cause this crisis and likely had relatively minor effects on its intensity, the framework is essential to our blueprint. This is because the type of crisis that is coming next is not known ex ante, so it is sensible to take actions to curb such excesses during the boom.

We refer to the period as of this writing as the COVID-19 crisis aftermath, and it is associated with very substantial additional economic and financial damages in many countries. These problems differ dramatically in types and causes from those experienced during the early stages of the COVID-19 crisis and appear to be triggered by very different origins than the virus shocks that precipitated the crisis.

The aftermath in the COVID-19 crisis context refers to the time period after which the real economy, banking sector, and financial markets had essentially achieved escape velocity from their early crisis nadirs. The aftermath roughly begins when recoveries in economic and financial markets are largely proceeding on their own without need of additional government monetary and fiscal stimuli or financial aid to distressed economic and financial sectors or industries. In addition, vaccines to reduce virus severity and spread are sufficient to quell much of the fear of additional widespread lockdowns, at least in nations with strong democratic traditions. Populations also have sufficient financial resources in many nations to return to confident spending in opening economies. The aftermath as we roughly describe it here arrived a significant time ago in some nations. For example, in the US, virtually all economic and financial indicators were pointing up by early 2021, vaccines were poised to be widely available, and the positive economic and financial surprises of recovery appeared to be accelerating.

The new and different damages to the real economy during the aftermath are in the form of high and variable inflation, domestic and international supply chain disruptions, insufficient labor force reengagements, and increased likelihoods and actualities in some nations of second COVID-19-related recessions. In the banking sector, traditional banks are again setting aside significant additional reserves for expected loan losses, reducing bank capital that might otherwise be available to support new lending as a cushion to absorb normal credit losses. In addition, nontraditional DTFFs dealing largely in cryptocurrencies in a number of cases have ceased functioning in relatively short order. Financial markets for traditional assets have in some cases entered bear market territory with losses of 20% or more, while some relatively new nontraditional assets such as cryptocurrencies have recorded much greater percentage losses.

The sources of these problems appear to differ substantially from the negative shocks to supply and demand to reduce disease spread in the early part of the COVID-19 crisis. In some cases, the sources are traditional misallocations of resources that occur during the exuberance that tend to occur when speculative bubbles are fed by human foibles during booms. In the case of COVID-19, the aftermath problems may have more origins in continuations into the aftermath of some of the public policy actions to respond to crisis conditions and other continuing factors and their interactions, some of which continue as of this writing. Thus, there may be cases of too much of what were initially good things. Additional policy stimulus after economic recovery escape velocity was achieved may have resulted in excess demand that exceeded supply chain capabilities as well as continued low labor force participation. There are additional key factors, such as deglobalization efforts to erect additional barriers to immigration and free trade across borders, and shocks, sanctions, and retaliations from the war in Ukraine, still ongoing as of this writing that also play important roles in creating or exacerbating these problems.

Because the aftermath damages remain ongoing as of this writing, it is too early to tote up the long-run costs, provide confident research-based assessments of the relative contributions of the different policies or events, or determine how such damages may have been significantly mitigated by better policy choices ex ante. Future economists and policy analysts will figure these out eventually, but we are not waiting with our book because there is plenty to report already.

The entire set of COVID-19 issues of economic and financial damages, the effects of policy actions on these, existing research findings, and unfinished research agenda on the aftermath call for current action in our view. What are needed now are compilations of the research and data on the economic and financial impacts of the COVID-19 crisis from around the globe, a comprehensive assessment of these findings, and a set of specific research and policy strategies or blueprint for contending with future crises based on this assessment. This book, The Economic and Financial Impacts of the COVID-19 Crisis Around the World: Expect the Unexpected, provides such compilations, assessments, and strategies. Our compilation of research is as complete as possible, drawing on theoretical contributions to the research literature and empirical papers and using data from many nations. We acknowledge overrepresentation of empirical research studies using US data, as often occurs in reviews of research in economics and finance. This reflects the supply of quality research available in the literature, as opposed to our intentions. This does not deter us from including research and data on other nations to the extent possible, and it does not impede us from drawing best-informed conclusions from the research.

The data we compile provides information over time from the years prior to the COVID-19 through the crisis and partially into the aftermath. In most cases, the real economy data shown are through 2022, the banking data continue through 2021 because of reporting lags, and differ by country and market for financial markets. The COVID-19 statistics for virus cases, deaths, and vaccination rates by country are cumulative as of December 2022. Additional statistics for the US and some other nations are available on a more ad hoc basis. The data are all publicly available, although not always free of charge. The data are drawn from a variety of sources, including central banks, other government agencies, educational institutions, news organizations, and international organizations such as the International Monetary Fund, and World Bank.

We display the data from a number of different views and grouping of countries in the various chapters and Appendix. Our data compilation does not significantly overrepresent US data as our research compilation does, although our examples often focus on US information. Such information is generally easier to find than information on other nations due to more intensive news coverage and greater public data availability.

To enhance the readability of the book, we avoid excessive footnotes with URLs of websites from which data or other information are drawn, many of which we access multiple times. We list the URLs that are not otherwise provided throughout the book in alphabetical order in a single footnote here for readers’ reference.²

Given the ongoing economic and financial damages of the aftermath and inabilities to complete quality research concerning them, the chapters on the aftermath that appear later in the book are primarily focused on the compilation of data. Most of the compiling, assessing, and setting strategies based on the research are confined to the other parts of the COVID-19 crisis.

Our comprehensive approach assesses all three economic segments of the real economy, banking sector, and financial markets. We also take a holistic approach to economic and financial cycles by considering all three phases of the boom, crisis, and aftermath, with the limitation on aftermath coverage of the COVID-19 already noted.

Our blueprint for specific strategies for contending with future crises is summarized in the "Expect the Unexpected" catchphrase at the end of the book title. Deriving these strategies from all of the analyses beforehand is the ultimate focus and inspiration for the book. These strategies for dealing with future crises involve advanced planning over the boom, crisis, and aftermath phases of the cycle and keeping these plans flexible to absorb and utilize new information as it arrives. To borrow from our esteemed colleague René M. Stulz who generously contributed the Foreword to the book, our approach may be roughly thought of as a risk management plan for the economy and financial system. As we demonstrate at the end of the book, the "Expect the Unexpected" blueprint may also be adapted for contending with other types of