The UK economy after the pandemic

In order to steepen the supply curve, the Bank of England immediately cut interest rates and extended its quantitative easing programme. 

Having put the economy in the freezer, it’s hard to imagine that it can be unfrozen without some scarring.--Richard Buxton

The aim is that many more companies will be able to stay in business as a result of the furlough scheme and other measures, than would have been the case, if no action was taken, keeping the supply curve relatively steep.

On the demand side, the government’s furlough scheme means that when the lockdown does end, the demand curve should be steeper than would otherwise be the case.

This is because when the lockdown ends, furloughed  workers will have had at least 80 per cent of their salary to spend, instead of social security payments plus savings.

This idea, that the demand curve will be steeper than is typically the case in a recession while the supply curve can be steepened easily is the rationale behind many investors view that the exit from recession will be rapid.

In the lockdown, spending the 80 per cent of salary they have received may be difficult; creating surplus cash to spend later and leading to a rapid steepening of the demand curve.

Mr Buxton describes this as the “optimistic scenario”, and while not dismissing it entirely, he says it’s not his base case, due to a phenomenon economists call “the paradox of thrift".

He says: “Having put the economy in the freezer, it’s hard to imagine that it can be unfrozen without some scarring.

"Some companies will not survive this, so unemployment will go up, and that reduces demand. But the data shows that it’s the fear of impending unemployment that has the really negative impact."

Table below assesses the potential impact of the coronavirus on the economy and public finances

Source: OBR

Fear factor

The “paradox of thrift” is a theory popularised by Lord Keynes.

It states that far more people think they will lose their job or suffer some other deterioration in their financial circumstances than actually do.

The pandemic has led to a worst-case recession, and economic figures suggest a wasteland, with the expectation of even worse to come over the second quarter.--Fahad kamal

This causes them to rein in their spending, which causes the demand curve to flatten by more than it otherwise would have done, and so unemployment will rise by more than otherwise.

This may mean that the furlough scheme fails in its aim to steepen the demand curve.