During the early days of the pandemic forecasters everywhere tried to draw parallels with previous epidemics in a rough attempt to predict an unpredictable year. Now that we are hopefully nearing the end of the crisis it seems pertinent to compare how the economic crisis unfolded compared to those initial expectations.
This post will unpack how the Australian economy was expected to fare over 2020, how the reality differed from these expectations and why.
The RBA’s Statement on Monetary Policy provides a useful set of forecasts each quarter which nicely capture the consensus view at four points in the pandemic.
The pre-pandemic February edition which largely assumed a world without a global pandemic.
The May publication which was formulated during the first lockdown, albeit after the peak of the March crisis.
August which was put together just as Victoria went into it second lockdown.
Finally the November issue where it appeared that Australia had finally returned to some sort of “Covid normal”.
The graph below shows forecasts of the unemployment rate and the actual outcomes over the year. Strikingly unemployment has been far lower than every pandemic-era forecast in 2020. Throughout the crisis economists consistently expected worse outcomes than actually occurred.
This is also true of other measures of economic outcomes such as GDP which was far less devastating than predicted. (Note both graphs include estimates for Q4 outcomes).
What can explain this divergence?
There are three main explanations for this forecasting error.
One the pandemic itself was not as bad as we first thought.
The effect of the pandemic on the labour market and economy was smaller than we thought.
The policy response to COVID-19 was more effective than we thought it would be.
All of these explanations are part of the answer, but I think the second and third explain most of the error.
Evidence for this can be seen by comparison to the UK. Covid-19 has spread well beyond initial expectations in the UK with 3 national lockdowns and a new more-viral strain. Despite this poor public health performance they are on course to have GDP declines over 2020 roughly inline with the Bank of England's initial expectations. More remarkably unemployment in the UK remains only 4.9% well below levels initially forecast!
The same is true of the US which has is now in a crippling third wave. Despite this unemployment is “only” 6.9%, when it was forecast to end the year over 9% back in the relative calm of June 2020.
While the Australian economy has undoubtedly benefited from an exceptional public health response the virus’s impact on GDP has been smaller than expected. This unexpected economic resilience combined with the various job subsidies around the world has meant that the impact on the job market has been far lower than initially forecast.
What does this mean for the economy in 2021? One could conclude that the overly dire forecasts meant that policymakers over responded last year and that this economic support should be wound back.
But I think this is incorrect. One of the main lessons of the crisis has been that unemployment caused by public health restrictions is not the same as the demand driven unemployment that defined previous recessions. Employment bounces back much quicker when lockdowns are eased - at least assuming the government provides some degree of economic support.
But with the notable exception of the border restrictions Australia is one of the most unrestricted developed economies. With the exception of areas reliant on immigration much of the economy is approaching a Covid-normal situation. This suggests that the unemployment that does exist within the economy (still at an eye watering 6.8%) may have metastasized into a longer term problem with more conventional recovery times. If so fiscal and monetary policy should continue to support the economy and actively support employment in 2021.
To use a somewhat an personal analogy, much like a dislocated arm once doctors have solved the problem the worst of the (economic) pain quickly dissipates. But getting back to your previous condition - let alone full employment - can be a much longer and harder slog.