Covid economic scarring is not inevitable, but it is becoming likelier with a second wave of the virus and “fiscal fatigue” setting in. Central banks are determined to ensure scarring does not materialise, but fiscal decisions matter more. The risk is that politicians, worrying too much about “the long term”, are embracing a deafest attitude that will ultimately be self-fulfilling. Economic scarring is highly likely without an adequate fiscal offset.
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No scarring? – Consensus thinks COVID-19 is a “bump in the road”, with no lasting scarring. GDP stays below where it would have been but gap stays the same. This would be very unlike 2008. After the Global Financial Crisis, the shortfall in activity kept increasing.
Zombification - Even if policy prevents a “credit event”, corporate zombification could further hurt productivity. The authorities face difficult trade off. Do they support demand, allowing zombification, even if this hurts longer-term efficiency?
People will spend more time unemployed – 1980s showed powerful hysteresis in labour markets. People who have been out of work for long spells lose skills and face discrimination from employers. Recent euro crisis had lasting impact on youth income prospects.