Monthly Economic Letter – March 2021

The COVID recession: Why this time is different

While it’s still too early for a full post-mortem on the COVID-19 recession, we know the pandemic has produced the worst contraction in Canada during the post-war period. A year of intermittent lockdowns, school closures, telework and other disruptions has had a huge impact on the economy.

This month, we look at key trends during previous recessions to see what distinguishes them from this one, and how the recovery will unfold in the coming months.

A recession doesn’t just happen

Canada has experienced five recessions since 1970, and twelve since 1929. In recent times, Canadian recessions have evolved to be less frequent but more severe events, according to the C.D. Howe Institute.

Recessions usually last between three and nine months. The most recent one, in 2008-09, lasted seven months. Typically, recovery periods—the time it takes to return to pre-crisis levels of economic activity—are long because post-recession growth is weak.

Recessions don’t just happen because the economy has been growing for a decade. Looking at past business cycles in Canada, recessions have been caused either by aggressive interest rate hikes or by some kind of economic shock, such as an oil crisis.

Dawn after the dark night

After a recession comes recovery. It begins when the economy starts to grow again and ends when it reaches its pre-recession level—from the trough to the old peak.

A typical feature of previous recessions is that the level of economic growth before the crisis was unsustainable. This is often referred to as an overheated economy or a bubble. In a slow-growth context, it is more difficult to return to the level reached before the downturn.

In both the way it started and its anticipated recovery, the COVID recession truly is different—a black swan event.

Before the pandemic hit, growth had already started to slow in Canada and expectations were for a soft landing, not a recession.

Now, indications are the recovery will be much faster than in previous recessions, even though Canada has experienced the worst GDP drop in decades. Three factors explain why we expect the economy to recover more quickly.

 

1. A mixed impact on production capacity

A decline in economic activity during a typical recession translates into lower investment and job losses. Recessions therefore lead to the destruction of an economy’s productive resources. Physical assets often become obsolete, and workers become discouraged after being unemployed for too long.

During this recession, health restrictions have certainly taken on a toll on certain types of assets. Offices are deserted and airplanes are grounded.

 

However, airplanes won’t stay on the ground forever, and people will eventually go back to offices. Additionally, the pandemic has forced entrepreneurs to adopt digital technologies faster than they had anticipated. This could mitigate the impact of the recession on productivity this time around.

Unemployment is still high in Canada (8.2% in February). However, several sectors have recovered lost jobs fairly quickly. Labour shortages are even beginning to emerge in some industries, and immigration restrictions could exacerbate the situation. When health restrictions are lifted and the economy recovers, workers may be in short supply, hindering Canada’s economic recovery.

 

2. The wealth effect of COVID-19

Another unusual aspect of this recession is the wealth effect it has created. In contrast to previous downturns, the balance sheets of companies and households have held up well.

An inability to spend due to lockdowns and government transfers have led to a significant increase in household savings. As the restrictions are lifted, part of this accumulated wealth will be injected back into the economy.

At the same time, government assistance to businesses, such as rent and wage subsidies, has softened the recession’s blow. Since the beginning of the pandemic, there has actually been a downward trend in the number of business bankruptcies. Government transfers should remain in place until the economic situation improves and continue to limit the impact of the recession on businesses.

 

3. Low interest rates

A massive injection of liquidity into the economy is expected to lead to a generalized increase in prices (inflation) in response to strong demand following the reopening. However, interest rates should remain accommodative for a good period of time.

The Bank of Canada, like other central banks, will likely be cautious about raising rates as it attempts to support solid and sustainable economic growth. While rates will undoubtedly rise one day, central banks have learned from experience that a gradual and controlled increase in rates is what’s called for following a recession.

 

What it means for your business

Recessions obviously make casualties, but many entrepreneurs have shown great resilience during the COVID crisis. With the recovery now in sight, the economic environment left by this recession is different from earlier Canadian economic downturns.

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