The financial crisis of 2008 and the pandemic

When comparing the financial crisis of 2008 with the emerging, pandemic-induced crisis, one can see that although they share some common symptoms, the underlying condition differs. This difference is important because it affects the line of treatment and the estimated duration of the economy’s recovery. Free from the fear of political cost, countries and central banks are going to adopt more courageous and, therefore, more efficient measures.

It is part of human nature to use information stored from experience as a way to predict the future. Therefore, it is only natural that economists, academics and politicians turn to the 2008 financial crisis as a model to gauge the ways in which the present pandemic crisis will impact the economy.

Most people compare the symptoms but overlook the underlying causes. As in 2008, we are witnessing a significant drop in the asset prices due to the increase of the risk discounting. This in turn translates in increased borrowing costs for countries, businesses and households alike. The steep drop in prices will lead to the readjustment of investment plans on the part of businesses. Specifically, trying to keep costs under control, firms  are going to postpone growth-oriented projects.

Moreover, the slowing down of the real economy will hurt employment and the household income as it had done back in 2008. In Greece, specifically, the drop in tourism and domestic consumption will delay the anticipated recovery. To use a parable, Greece’s economy can be likened to a patient who just got out of surgery and is about to be dismissed from hospital when, suddenly, he is hit by a nosocomial infection.

Although, in both crises, symptoms in the markets and in the real economy are similar, the underlying condition couldn’t be more different. The crisis of 2008 was an endogenous one since it had originated from the economy itself or from the financial system. The extended leverage combined with the undertaking of extreme risks led the global financial system to collapse. In the case of Greece, specifically, the endogenous crisis had been attributed to the lack of competitiveness and the flimsy structure of the domestic economy. 

Conversely, in the current crisis the disease is exogenous. The pandemic is not caused by an instability in the financial system nor is it due to a fault inherent in the economy. As a matter of fact, prior to the virus’s spread, predictions spoke of global growth, banks had sufficient capital, and industries foresaw increased profitability. The only cacophony were the high valuations for a part of the equities due to the prolonged stock market rise, however most valuations were justified by the low interest rates and strong corporate profitability. Consequently, the financial crisis resulting from the pandemic cannot be attributed to the extravagance of the European South, or the austerity of Europe’s North or from some sort of exaggeration on the part of financial markets.

So, why it is important to tell the difference between the two underlying conditions? Because, treatments will be different and, possibly, more effective. The lack of moral hazard enables central banks and countries to take measures, free from the fear of political costs. No citizen in their right mind will blame the ECB for buying South’s bonds or go to European courts to challenge ECB board’s decisions. And it is not likely that people will judge Germany’s government for the upcoming change in its fiscal policy and the abandonment of the black zero dogma. The social acceptance of the necessity for a powerful financial treatment is the most critical factor for its success. Greece’s unconditional participation in ECB’s new program of quantitative easing illuminates this very difference.

An additional stabilizing factor is that, being border-insensitive, the COVID-19 plight is affecting the world’s developed and under-development countries; therefore, implementing relief measures simultaneously in the US, Europe and Asia, has multiplying benefits provided that initial setbacks in coordination are overcome and unilateral politics at the expense of the remaining countries are avoided. The economic shock could even mitigate the US-China ongoing trade war, thus obliterating an additional uncertainty factor.

The crisis we are experiencing won’t be without significant short-term effects. Nevertheless, a consensus in society and the political staff on the necessity of unconventional measures will contribute to their effectiveness. A patient aware of his condition is more likely to respond to treatment and win the battle ­– so long as he remains optimistic. So, let’s try to look at things a little more optimistically.

Read the article in Greek as published in Kathimerini.gr