Undersaved, over-levered households and businesses were overdue for a secular shift to more self-preserving financial management well before the pandemic hit. Now, new research points out that COVID-19 may well solidify that behavioural shift for years hereafter and fuel deflationary forces in the process.
A paper from the Centre for Economic Policy Research points out that historically, pandemics are associated with falling real rates, depressed asset returns, and excess saving for decades following such outbreaks. See The long-run economic consequences of pandemics:
The great historical pandemics of the last millennium have typically been associated with subsequent low returns to assets. Measured by deviations in a benchmark economic statistic, the real natural rate of interest, these responses indicate that pandemics are followed by sustained periods – over multiple decades – with depressed investment opportunities, possibly due to excess capital per unit of surviving labour, and/or heightened desires to save, possibly due to an increase in precautionary saving or a rebuilding of depleted wealth.
A further implication of our analysis in the current low interest rate environment pertains to the secular stagnation hypothesis (Hansen 1939, Summers 2014). If the historical trends we have highlighted play out similarly in the wake of COVID-19 – adjusted to the scale of this pandemic – then secular stagnation would remain a concern for monetary and fiscal stabilisation policy for the next two decades or more.
The researchers note that a deflation-moderating factor this time may be where younger populations remain less physically impacted and longer living than in past pandemics.
Buying assets at historically discounted valuations is essential to improving prospective investment returns in this environment, but so too is the continuation of income payments (interest, dividends, rents, royalties) on the assets, once purchased. We are first likely to see more dividend cuts and defaults before investment yields can stabilize.
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