Psychological scars of downturns could depress growth for decades

FOR THE past 40 or so years, economists, central bankers and other eminences have gathered against the imposing backdrop of Wyoming’s Teton mountains every August, in order to chew over the great monetary challenges of the day. Not this year. As The Economist went to press the proceedings of the Jackson Hole symposium, organised by the Federal Reserve Bank of Kansas City, were unfolding online, thanks to covid-19. Those tuning in are all too aware of the economic damage wrought by the pandemic. But the headaches are only beginning. As one of the papers due to be presented at the conference explains, covid-19 is likely to reshape people’s beliefs about the world in ways that will complicate the already daunting task of restoring beleaguered economies to health.

The notion that a severe economic shock might do long-run damage is not new. Since the Depression macroeconomists have understood that deep downturns might tip an economy into a “liquidity trap”, in which interest rates fall to zero and monetary policy cannot easily provide a stimulating kick. Without a powerful dose of fiscal stimulus, the economy stays mired in a slump. Or a brutal recession may lead to “hysteresis” in the labour market, causing, say, a lasting increase in the unemployment rate. People out of work for long spells may become so disconnected from the labour market, as their skills and motivation erode, that even when demand recovers they struggle to find jobs. (In the 1980s Olivier Blanchard of the Massachusetts Institute of Technology and Lawrence Summers of Harvard University argued that this explained why unemployment was much higher in Europe than in America.) Both sorts of scarring could restrain economies as they leave the shadow of the pandemic.