Market volatility and economic policy in the age of coronavirus
Institutional Communication Service
11 May 2020
In the financial markets, volatility has never been as high as during the outbreak of Covid-19, which represents the classic ‘Black Swan’, or unexpected, event. High volatility can cause market turmoil leading to important effects on the economy as a whole. At the peak of the pandemic, economists and policy makers around the globe feared a more acute and persistent impact on the economy than during the global financial crisis of 2008. Antonio Mele, Full professor of finance at USI and Senior Chair at the Swiss Finance Institute, explains in a short video what occurred in the financial markets and the response of in terms of economic policy in Europe.
Market volatility has never been as high as during the outbreak of Covid-19. On March 16, the VIX index (also known as the “fear index”) hit its record high of more than 82 percentage points. During the peak phase of the pandemic, market data such as future prices on VIX showed that the investors’ concerns about the economic effects of the Covid-19 outbreak were more acute and likely to persist longer than during the global financial crisis that occurred just over a decade ago.
The reasons underlying these developments are very clear. At the time, market evaluations were probably already very high. For example, the market was already complacent about the fact that the Federal Reserve would continue to pursue a policy with ultra-low interest rates, and the only thing that would make investors change their minds about market evaluations might have been the occurrence of a “Black Swan” event. Covid-19 was indeed a highly unexpected event. Its economic effects were very clear since the beginning, with job losses reaching levels not seen since the Great Depression of the Thirties of the 20th century.
Market turmoil is always very worrying. When market volatility is high, investors sell. But when investors sell, market volatility raises further. This feedback loop certainly contributed to the complicated market dynamics that were observed in March. If, during these developments, some important financial institutions had to incur into a big loss, we would have witnessed to market dysfunctionalities reminiscent of the credit crunch that occurred between 2007 and 2009, with adverse consequences on an already seriously compromised real economy.
It is very reinsuring that, today, market volatility – and the level of general uncertainty in the markets and the economy – is much lower than it was two months ago. Economic policy around the world has certainly contributed to mitigate this uncertainty. Policy makers seem to have learned the lessons from the 2008 global financial crisis and the European debt crisis, injecting thousands of billion dollars into the economy through dedicated policy plans. Some of these plans were truly unprecedented.
Humanity had to face several extremely challenging moments in the last ten or fifteen years, namely the mentioned global financial and European debt crises, migration, climate change, and, now, the pandemic. It is likely that, today, we will learn from these history lessons and react to the current developments with coherent policy plans. The fact that Europe is trying to come up with common policy throughout a variety of projects should not be surprising. If Europe is a political project, it is very normal that its resolutions would reflect complex mediation mechanisms.