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Bubbles and crashes

When the invisible hand dishes out an invisible punch in the nose

Economic crises are a regular part of history. In a sense with the COVID-19 recession we have been here before, but there are features that make this recession unique. The beating the economy has taken in 2020 has been an incredibly fast and concentrated downturn. Even during the Great Depression of the 1930s it took several years before GDP fell 20%. During COVID-19 that kind of fall in GDP happened in a matter of months. The concentration of the downturn is intense and governments have had limited time to respond. Not to mention the downturn is ongoing as long as we don't have a vaccine. We are experiencing history if we like it or not.

History reminds us of how economic crises come about, and how we can address them. Below is an infographic of economic crashes over time.

Infographic/timeline of economic disasters

Feel free to share the infographic elsewhere and link to Byte Size Story

Recessions come in many shapes and sizes:

  • Often they are demand-driven with consumers or governments reducing spending in response to a loss of confidence.

  • Recessions could be supply-driven with companies reducing output, for example because of an earthquake.

  • Bubbles may burst or deflate with asset values (e.g. shares) falling in response to overly-inflated prices which can reduce confidence in certain sectors - we saw this during the Dot-com bubble of the early 2000s.

  • Banking or financial crises may arise with people losing faith in the financial system and withdrawing their deposit holdings from banks.

Several of these elements can play out in a crisis. COVID-19 has featured at least three of these with reductions in spending, reductions in production, and a fall in asset prices, however markets have subsequently rebounded. A common feature of all crises is the loss in confidence in the economy.

Economists devote considerable energy to finding ways to identify when a recession could happen. A common tool for predicted recessions is an inverted yield curve where the yield on short-term bonds is higher than long-term bonds. This implies that investors have limited confidence in the economy and perceive greater risk short term. We can anticipate that events like COVID-19 will happen and model the impact on the economy. However estimating when such an event will happen with any certainty is remarkably difficult, so preparing for them adequately is challenging. Anticipating recessions is both art and science, and economists haven't got it right.

There are multiple tools for fighting recessions. Central banks like the Federal Reserve reduce interest rates to encourage spending. Governments introduce large stimulus packages to support the economy and stimulate demand and employment. Large investments in infrastructure are common. During COVID-19 we have seen governments give money to the unemployed or businesses. Inevitably voters seek answers and reforms are proposed to try and make sure that "this never happens again".

There is no playbook for fighting COVID-19. However, recessions are nothing new and we do have some understanding of how to address them. Only time will tell if we do so effectively. I hope when we look back we can say people were looked after. Stay safe. Let’s try to make it to the other side in one piece.


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