The Office for Budget Responsibility (OBR) estimates UK GDP could fall by 13 per cent in the 2020 calendar year.
During the global financial crisis, the worst year for GDP decline was 5 per cent.
Richard Buxton, head of UK equities at Merian Global Investors says the economy has “effectively been put into the deep freeze” and the challenge facing policy makers now is to “unfreeze it.”
The economy is formed of two factors, supply and demand. On a graph, in a healthy economy, the level of supply should slope gently upwards, as should the level of demand.
The steeper both curves are, the greater the level of economic activity, and the ideal scenario is that the demand curve and apply curve slope gently upwards precisely in unison.
If the demand curve is steepening at a markedly faster pace than the supply curve, that means the demand is increasing at a pace faster than the supply of goods. This causes inflation, and can lead eventually to a recession as prices rise more quickly, causing demand to fall, with the demand curve flattening.
Companies respond to the fall in demand by reducing supply, which means workers lose their jobs, causing the demand and supply curves to flatten.
If the supply curve steepens at a much faster pace than the demand curve, then the economy has over supply, and companies faced with unsold inventory will reduce production, cutting jobs, and so also flattening the demand curve.
Response to financial crisis
The Global Financial Crisis was caused by a sudden flattening of the supply curve, as a crisis in the banking sector led to a reduction in the supply of credit around the world, meaning firms were unable to pay bills, or borrow to expand their operations.
That led to a flattening of the demand curve over a slightly longer period of time.
The response of policymakers was to pump money into the banks and the wider financial system in order to steepen the supply curve, and this eventually led to a steepening of the demand curve and the return of growth.
That asset prices rose to a much greater extent than did GDP growth or wage growth in the decade since the financial crisis indicates the supply curve steepened faster than the demand curve.
The government’s traditional response is to increase its own level of demand in the economy, replacing the reduced demand from the private sector, and so steepening the demand curve.
The pandemic response
With the coronavirus pandemic, it caused a sudden, sharp, flattening of the supply curve as the government ordered many businesses to close.
This had an obvious impact on demand, with that curve also flattening.
In order to steepen the supply curve, the Bank of England immediately cut interest rates and extended its quantitative easing programme.
Questions appear on the last page of this article.