Cliff Taylor: A big recession is coming but it’s not a rerun of 2008

I have an Italian friend who, when she calls her elderly grandmother, often hears news of the “lo spread.”

This is not something placed on toast. The "spread" is the gap between the price Italy can raise borrowings at and that charged to Germany, the cost of borrowing.

Like Irish residents, the Italians became obsessed with this cost during the financial crisis to the extent that it remains a common conversation topic.

In the months ahead, we will return to watching the markets and hoping that the current calm in government borrowing markets continues.

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Ireland enters this crisis in a good place, economically. Our long-term interest rate is at rock bottom, helped by an extraordinary programme of support outlined by the European Central Bank.

But we saw during the last crisis that these things can change and quickly.

Like us all, investors are asking how long this crisis will last and its impact.

The longer economic outlook is now one of unprecedented uncertainty.

Will there be a big downward economic drop and then a decent bounce, or something more prolonged which cause deeper damage to economies and people’s living standards?

The outcome of the public health response, in Ireland and internationally, will be vital. The sooner restrictions can be lifted, the quicker large parts of the economy can move out of the deep freeze and the less damage will be done to the structure of the economy.

Restrictions

However, how and when the restrictions will lift remains unknown – they will certainly not all disappear overnight.

So if you offered anyone in Government the chance to lock-in the scenario outlined by the Economic and Social Research Institute (ESRI) – with recovery setting in over the summer, albeit with a fall in economic output of 7 per cent this year – they would take your hand off.

This is a significant hit, but manageable.

Because if restrictions drag on, the economic damage could be much worse. Looking at the impact on both spending and tax revenues, you could estimate that if this happens, borrowing this year could rise from less than 5 per cent of GDP in the ESRI scenario to 8 to 10 per cent.

Let’s hope we avoid that.

But either way we are are looking at a situation where there will be permanent economic damage. The hit is too hard and the economic ripples are spreading too widely to avoid this.

This time it's different – we are seeing an extraordinary shut down in large parts of the world economy

When it is over Ireland’s economy will bounce – and probably quite significantly – as many businesses reopen. But some won’t.

And you would think that the place we all start from will be different from the one we left a few weeks ago. A lot of things will recalibrate – wages, job levels, house prices, spending, and so on.

The hit in terms of economic output may well be as big or bigger than during the previous economic crisis (we can no longer refer to it as “the” economic crisis). But this does not mean that we are looking at a re-run.

Then, the EU entered a doom loop where bust banks infected sovereign governments, nowhere more so than Ireland.

Different

This time it’s different – we are seeing an extraordinary shut down in large parts of the world economy, a self-imposed demand shock.

Much of the activity now stalled will resume – we just don’t know when and how much.

The hope is that this will be a major and sudden downward hit to the economic cycle, a significant part of which can be recouped.

And remember that the Irish economy enters the crisis in good general health, with a strong and productive base and without the kind of giant bubble which had inflated heading into 2008.

The budget has moved into surplus and we have reasonable cash reserves.

But this won’t be easy – and there are big risks. The longer the restrictions go on, the bigger the economic damage, in Ireland and globally.

After the big wave of Covid-19 cases passes, the Government here, like its counterparts worldwide, is going to face tricky decisions on what restrictions to lift and when.

You could, for the sake of argument, see a fair number of the domestic restrictions lift over the summer and many shops and other outlets reopen.

But when will we be able to start going to football matches, or into a crowded indoor setting like a pub?

And when will people start travelling again for business or pleasure?

The autumn? 2021?

I’ve no idea, but these are big economic questions.

Investors lending money to governments are mulling these questions too. It is vital Ireland retains their confidence and if they can see the economy start to recover this will be a lot easier.

If, on the other hand, they fear a longer and more damaging downturn, with the structure and productive potential of the economy damaged, it could be trickier.

Advantage

For the moment Ireland has the very considerable advantage of major ECB intervention which, if it works, will allow us to borrow the money we need at low interest rates. In turn, being able to do this makes the sums all much more sustainable.

What we don’t want is a new type of euro crisis – the problems faced by Italy in particular are a threat.

And we saw this week that EU governments yet again failed to step up to the plate in preparing an adequate fiscal response, or a plan for commonly guaranteed borrowings.

So Ireland will aim to keep its head down and raise money on the markets in the months ahead to pay the massive bills to pay for the impact of Covid-19.

We will hope that the ECB can keep interest rates down. We will all watch the “lo spread”.

And we will hope the worst case scenario does not emerge, that normal life can slowly resume and the economy start to recover.

It is an outlook worth fighting for and spending a lot of money to try to achieve. But there are big risks too and this crisis is unprecedented and so we have no alternative but to do what we can, hope for the best and push on.