Commentary: A financial crisis is underway, as demand collapse ripples through companies across the world

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There is good reason to worry that the world economy is heading into a deep, protracted recession, says Eswar Prasad and Ethan Wu.

Unlike the crash from 2008 to 2009, which was triggered by liquidity shortages in financial markets, the COVID-19 crisis involves fundamental solvency issues for firms and industries well beyond the financial sector.

The US economy has come to a virtual standstill, with most of the services sector shut down, industrial activity disrupted, and a red-hot labour market giving way to a tidal wave of unemployment in the space of just a few weeks. In some respects, China’s command economy is better positioned than market economies to withstand such massive shocks, because the state can marshal national resources beyond the limits of conventional macroeconomic tools and provide direct support to enterprises and banks.

Making matters worse, some of these countries must cope with capital-flow reversals, depreciating currencies, and plummeting export demand. Others face formidable debt loads that are becoming only more difficult to finance. Central banks, at least, are stepping up to the challenge. The US Federal Reserve has taken extraordinary measures to bolster financial markets through asset purchases, and to provide dollar liquidity to many foreign central banks.

 

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