**2. The effect of COVID-19 on the world economy and the financial system**

There is little doubt that the COVID-19 pandemic has caused an extraordinary human and health crisis. The measures taken by governments all over the world necessary to contain the virus have resulted in an economic downturn whose severity and length are still quite uncertain. Initially, the pandemic was seen as a China/ Asian regional shock; however, very quickly, it became apparent that the virus was 'travelling' quickly and that the shock would indeed be a global one. It is now clear that the last time the world economy suffered such a shock was after the demise of Lehman Brothers in September 2008. Under this 'prism', Baldwin and Tomiura [1] point out that the GFC could provide a broad perspective on the range of likely outcomes this time around; more specifically, the authors refer to what came to be known as the 'great trade collapse', which was the steepest fall in world trade since the Great Depression (see **Figure 1**).

As far as global economic growth is concerned, recent IMF estimates [2] indicate a decline of 3% for 2020, which incidentally is worse than the one experienced during the GFC. At the same time, the timing and—importantly—the shape of a potential future recovery remain uncertain. Within this context, Mann [3] argues

that this crisis will probably be a U-shaped one (rather than a V-shaped one), on the grounds of what happened as a result of other epidemics. Having said that, however, we need to stress out that, from an economic perspective (and not only), COVID-19 is different from other pandemics (Asian Flu, Hong-Kong Flu, Avian Flu, SARS, MERS, and Ebola Virus Disease), in the sense that they either 'hit' nations that were not so dominant economically or the number of registered cases was much smaller; we should not forget that the current pandemic has greatly affected the G7 plus China, among several other countries.

Given the above developments on world trade and economic growth, unavoidably the global financial system has also felt a dramatic impact with the asset prices falling sharply; actually, according to the IMF [2] (see **Figure 2**), several stock markets across the world experienced declines of 30% plus at the worst point of the sell-off (we should note that most of them have recovered since then). Moreover, worrying signs were also observed in important short-term funding markets, including that for US dollars, as well as other credit markets, with spreads rising substantially. The strain experienced by financial markets may also be seen through the volatility 'lenses', where spikes in volatility reached levels not seen since the GFC, reflecting the uncertainties caused by COVID-19 (see **Figure 3**).

#### **Figure 1.**

*Quarter-on-quarter growth, world imports volume, 1965–2019 Q3. Source: Baldwin and Tomiura, elaboration on WTO online data (www.WTO.org).*

#### **Figure 2.**

*Asset market performance as of April 9, 2020 (measured in percentage points and basis points). Source: IMF, global financial stability overview, April 2020.*

**5**

**Figure 5.**

*stability overview, April 2020.*

**Figure 3.**

**Figure 4.**

*Introductory Chapter: Financial Crises DOI: http://dx.doi.org/10.5772/intechopen.93415*

Within the above framework, and given the need to stabilise the global financial system so as to support the real economy, as is often the case, central banks had to take bold action. To do this, they had to re-activate 'weapons' used during the course of the GFC in order to contain the upward pressures on the cost of credit and make sure that firms and households would have access to credit (at a reasonable price); effectively, central banks stepped in as 'buyers of the last resort' of risky assets, such as bonds issued by firms, including high-yield ones. Moreover, central banks in advanced economies cut interest rates to historically low levels (see **Figure 4**) while substantial interest rate cuts were also observed in emerging markets. Finally,

*Volatility indexes (measured in percentage points). Source: IMF, global financial stability overview, April 2020.*

*Actual and expected policy rates. Source: IMF, global financial stability overview, April 2020.*

*Cumulative non-resident portfolio flows to emerging markets (% of GDP). Source: IMF, global financial* 

*Introductory Chapter: Financial Crises DOI: http://dx.doi.org/10.5772/intechopen.93415*

Within the above framework, and given the need to stabilise the global financial system so as to support the real economy, as is often the case, central banks had to take bold action. To do this, they had to re-activate 'weapons' used during the course of the GFC in order to contain the upward pressures on the cost of credit and make sure that firms and households would have access to credit (at a reasonable price); effectively, central banks stepped in as 'buyers of the last resort' of risky assets, such as bonds issued by firms, including high-yield ones. Moreover, central banks in advanced economies cut interest rates to historically low levels (see **Figure 4**) while substantial interest rate cuts were also observed in emerging markets. Finally,

**Figure 3.**

*Financial Crises - A Selection of Readings*

that this crisis will probably be a U-shaped one (rather than a V-shaped one), on the grounds of what happened as a result of other epidemics. Having said that, however, we need to stress out that, from an economic perspective (and not only), COVID-19 is different from other pandemics (Asian Flu, Hong-Kong Flu, Avian Flu, SARS, MERS, and Ebola Virus Disease), in the sense that they either 'hit' nations that were not so dominant economically or the number of registered cases was much smaller; we should not forget that the current pandemic has greatly

Given the above developments on world trade and economic growth, unavoidably the global financial system has also felt a dramatic impact with the asset prices falling sharply; actually, according to the IMF [2] (see **Figure 2**), several stock markets across the world experienced declines of 30% plus at the worst point of the sell-off (we should note that most of them have recovered since then). Moreover, worrying signs were also observed in important short-term funding markets, including that for US dollars, as well as other credit markets, with spreads rising substantially. The strain experienced by financial markets may also be seen through the volatility 'lenses', where spikes in volatility reached levels not seen since the

*Quarter-on-quarter growth, world imports volume, 1965–2019 Q3. Source: Baldwin and Tomiura, elaboration* 

*Asset market performance as of April 9, 2020 (measured in percentage points and basis points). Source: IMF,* 

affected the G7 plus China, among several other countries.

GFC, reflecting the uncertainties caused by COVID-19 (see **Figure 3**).

**4**

**Figure 2.**

**Figure 1.**

*on WTO online data (www.WTO.org).*

*global financial stability overview, April 2020.*

*Volatility indexes (measured in percentage points). Source: IMF, global financial stability overview, April 2020.*

#### **Figure 4.**

*Actual and expected policy rates. Source: IMF, global financial stability overview, April 2020.*

#### **Figure 5.**

*Cumulative non-resident portfolio flows to emerging markets (% of GDP). Source: IMF, global financial stability overview, April 2020.*

central banks have also provided liquidity to the financial system through Open Market Operations (OPM). These actions have certainly helped to 'calm' markets, some of which have substantially recovered lately; however, despite this, it should be noted that investor sentiment is still fragile.

Putting all the above together, the deterioration of the global economic outlook has dramatically changed the 1-year ahead projections of global economic growth; actually, according to the IMF [2], it has shifted it massively to the left (there is a 5% probability that it will fall below −7.4%; same as referring to an event that is expected to happen once every 20 years). It is quite possible that, as so often happens at times of financial crises, emerging markets are hit the hardest, since investors tend to withdraw their capital and look for so-called 'safe-haven' assets (**Figure 5** below 'speaks for itself').
