Between recession and boom: 2021 can be a year of disillusionment – the economy

In the last few decades, insecurity for people and the economy has rarely been greater than it is today. Forecasts – whether in terms of health or the economy – have rarely been more difficult than this year. Many economic forecasts are currently shaped by a pious desire to think about a rapid end to the pandemic and an immediate economic recovery in 2021.

This should prove to be an illusion. Because too many things could go wrong next year – the recovery would be more difficult and take longer than many people currently want to imagine.

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In times of such enormous uncertainty, every economic prediction is condemned not only for inaccuracy, but simply as erroneous. That is why it is so important that we openly and honestly emphasize the limitations of economic forecasts in the economy. In these times, our forecasts are just a little more than scenarios, ie if-then analyzes that depend on assumptions that are difficult to estimate – on the spread of a pandemic, the global economy, corporate insolvency, consumer and savings behavior, banks’ reactions and much more.

Some of the assumptions will inevitably not be correct, and forecasts are therefore very likely to be lacking in reality. However, forecasts are valuable if they help decision-makers in politics and business, show causal relationships and possible policy tools.

A year ago it was said: the economic boom

Probably never before have economic forecasts had to be changed so massively in such a short time as this year. An economic boom was still expected in January, because – despite all the warnings from China – they simply did not have the imagination to spread the pandemic to Europe and the world.

This was followed by disillusionment, the economic Armageddon. This was reflected in the June forecasts, which saw an economic downturn of up to ten percent in Germany this year. This fear was followed by exaggerated euphoria as the economy recovered in the third quarter, in part due to the boom in China and other Asian countries.

DIW President Marcel Fratzscher warns against excessive euphoria by Daniel Naupold / DPA

Meanwhile, the insight stated that with the continuing second wave of infections, the economic crisis would not end soon. The German economy will shrink in the fourth quarter and could do very well in the first quarter of 2021, so it is likely that the economy will fall into a second recession.

The weakest pay the highest price

2021 could be a year of disillusionment, at least in terms of the economy. Corporate insolvency could increase significantly, as many of them are so heavily indebted that they no longer receive or no longer want bank loans, have exhausted reserves and the postponement of companies’ insolvency applications expires. Along with the problems facing society, unemployment is likely to rise, and especially the weakest ones, such as mini-workers, are likely to pay the highest price.

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Lower private consumption will further weaken companies. This could complicate the provision of bank loans to many companies. Failure to repay the loan could in turn get some banks into trouble and also reduce their loans to healthy companies and households. Such a vicious circle could have formed more easily than many thought. Although most banks today are more resilient than before the global financial crisis, politicians and banking regulators need to identify such problems at an early stage to avoid a systemic crisis.

“America first” remains the motto among Biden

The global economy, on which Germany depends on its high exports, could also face nasty surprises in 2021. The Asian economy is booming, but hopes the new US administration will change course, likely to be disappointed. Because Joseph Biden has already indicated that he will continue the policy of “America First” of his predecessor Trump, albeit with a friendly face.

In addition, the European economy is and will remain a global weakness with many factors of uncertainty, including Brexit. With 60 percent of German exports going to European countries, the German economy will not be able to escape European poverty either.

In conclusion, 2021 could be significantly less positive than the more optimistic economic forecast scenarios see, and everyone hopes. A wise economic policy strategy must prepare for various risks in order to act quickly and effectively. However, the highest priority must first be the premature termination of the second wave of infections, as its continuation and the associated blocking until the spring would cause enormous and permanent damage.

Marcel Fratzscher heads the German Institute for Economic Research (DIW) and is Professor of Macroeconomics at Humboldt University in Berlin.

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