We recently mapped out a set of plausible scenarios to try to understand which way the wind might blow for the global economy in the coming months.
In our single most likely scenario – our good recovery scenario – we see a successful global rollout of the various vaccines which prove effective. The upshot is that much of the world reaches herd immunity levels during 2021 and it proves possible to start fully re-opening economies from Q2 onwards.
Marginally less positive is our inflationary scenario to which we assign a 20% probability. Here, confidence in the economy and employment prospects, strong consumer and business sentiment, paired with continued policy support, lead to a fast drawdown in excess savings accumulated in 2020 and a quick fall in the household saving rate from current elevated levels. Lower short-run supply capacity reduces the speed at which actual output can grow without generating price pressures. Meanwhile, firms take advantage of rapid growth in demand to rebuild profit margins by raising prices. The result? A short-term spike in inflation coupled with Fed interest rate intervention.
Our ‘stormy seas’ and ‘hysteresis’ scenarios are more pessimistic. In the former, vaccines turn out to be less effective and more difficult to roll out than expected. Weak demand means inflation falls further, more countries are forced to consider negative rates and markets begin to focus on long-run debt sustainability. In this scenario, neither the US nor European economies return to pre-crisis levels of economic activity until mid-2022 at the earliest.
‘Hysteresis’ is our worst-case scenario, albeit with only a 15% probability in our view. Here, the pandemic causes long-lasting economic damage through a combination of fundamental forces and self-fulfilling pessimism. Both physical and psychological scarring turn a temporary disease shock into a permanent hit to the level (and possibly growth rate) of economic activity. As a result, a number of major economies never return to the pre-pandemic trend.
Shamik Dhar, chief economist, BNY Mellon Investment Management.