How the COVID-19 Recession is Different from the 2008–09 GFC
Five Graphs indicating Potential Differences
From oxygen and non-durables shortages to highly restrictive social distancing measures. Economists can already grasp the peculiarities of the COVID-19 pandemic which turned it into a global life-threatening sanitary crisis.
In this short article, I outline some of the key statistics that made COVID-19 an unforgettable event, while comparing the consequential and short-term negative effects on the state of the aggregate economy with the 2009 Global Recession.
- TED SPREAD
TED stands for Treasury-Eurodollar spread and measures the difference (i.e., spread) between the 3-Month LIBOR rate and the 3-Month U.S. T-bill.
Based on a monthly-basis, the TED spread sky-rocketed from its latest upsurge (0.75% in April 2001 due to the explosion of the high-tech bubble in 2000–02) to 3.35 percentage points in October 2008, time “when the shoe dropped”. This was partially driven by a clear upturn in the 3-month LIBOR rate as early as in Jan.-08 vs. a violent and persistent drop of the (believed “default-free”) 3-month T-bill rate. Hence, consistent with economic logic, TED spread peaks during periods of financial stress.
Far from the concerning scenario in 2008–09 where European banks where highly indebted even before the housing crisis, TED spread peaked to its decade-high 0.82% in April 2020 but has decreased thereafter.
2. Fed Funds Rate vs. 10-Year minus One-Year T-bills
Recall that the federal funds rate describes the rate of interest at which liquid, depositary banking institutions lend to those with a shortage, by depositing cash on the Federal Reserve. These loans are normally overnight transactions in the money market and are contingent to the overall financial market sentiment.
The figure below compares the fed funds rate with the spread between 10-year and 1-year T-bonds rates. The difference between these two represents the yield curve for each period in time, hinging on the various maturities of the bonds. Notice the strong negative correlation between the two statistics.
After a robust and steady rise throughout the pre-GFC period, the fed funds effective rate decreased substantially once short-term financing markets were shut down. As believed, the spread narrows when the Fed undergoes tightening and vice versa. The graph below highlights the differences between 2008–09 and May 2020, yielding both statistics lower numbers for the latter period.
3. Three-month T-bill minus CPI (Consumer Price Index)
Before taking a closer look at the spread between the 3-month T-bill rate and the CPI in the U.S., I think it’s very useful to highlight the contrasting path of CPI through the pandemic recession.
After a major drop to -5% in April 2020, time when the major economies announced quarantines and isolation regulations, the compounded annual rate of change in prices escalated exactly a year after to nearly 11%, its highest benchmark ever recorded in the 21st century. It then swinged down last August due to heavy global supply shortages (i.e., chips and non-durables) in the developed economies. However, it remains notably high at 7% compared to its pre-pandemic equilibrium level.
Cumulative CPI fluctuated by a fewer scale during the 2008–09 GFC remaining interestingly closer to the Fed’s medium-run inflation target at 2%.
The spread between the 3-month T-bill rate and the CPI is, hence, consistent with the prices volatility experienced lately which have brought this spread to the negative zone. This imposes greater pressure in financial markets especially for money managers sine holding liquid, highly marketable asset classes like 3-month treasuries prove to be unprofitable in the short-term considering the current inflation rate, i.e., a greater slice of the investor’s purchasing power (merely real interest rates) is being eroded.
5. Housing Prices
Housing prices, as measured by the S&P/Case-Shiller U.S. National Home Price Index, have been unaffected by the pandemic. The GFC was a housing-bubble driven financial crisis when excessive and highly risky lending took place with very high LTV ratios.
When housing prices started to fall and housing demand cooled off, extremely indebted households unable to repay the interest rate on their “subprime” loans began to default which brought the whole system to its knees.
A major distinction must be made between the GFC and the COVID-19 pandemic in terms of the causes that led to the actual recession. The pandemic was a sanitary crisis which mutated into an economic recession, as a consequence of a halt of the economic activity both in domestic and cross-border markets. Meanwhile, the 2008–09 GFC origins are very much different as already argued.
Nevertheless, stay-home working put upward pressures on job losses with the unemployment rate jumping to over 14% in April 2020 a level not seen since the 1930s.
Despite many losing their jobs especially those from low-wage industries, the US labour market has proved to gradually move back to its January 2020 level at 4%.
Bibliography
Federal Reserve Bank of St. Louis (2017). ‘How Might Increases in the Fed Funds Rate Impact Other Interest Rates?’. Available at https://www.stlouisfed.org/on-the-economy/2017/october/increases-fed-funds-rate-impact-other-interest-rates(Accessed: 19 February 2022).
