Predicting the economic effects of swine flu

July 17, 2009

dm1- Marie Diron is senior economist at Oxford Economics. The opinions expressed are her own -

A swine flu pandemic would affect the economy via various channels involving supply and demand.

On the supply side, infection and death imply that employees would be unable to go to work. This is what most people think about when they think about swine flu’s economic costs.

But the demand channels are likely much more powerful. Fear of infection would keep people away from airports, train stations, restaurants, cinemas and shopping centres. This would imply cuts in travel and tourism and consumer spending.

In addition, uncertainty about the impact and duration of the pandemic would dampen investment, while financial markets would probably experience renewed tensions with spreads between policy and market interest rates rising again and share prices negatively affected.

To get a quantitative estimate of the impact, we need to make a few assumptions. First, based on the experience of previous pandemics and developments so far, we can assume that 30 percent of the world and UK populations would be infected and be unable to go to work for two weeks. We also assume a death rate of 0.4 percent.

Second, we look at the experience of the SARS outbreak in Asia in 2003 to calibrate the likely cuts in discretionary consumption and international travel. This episode showed significant reductions, of around 20 percent and 60 percent respectively. In the current environment of rising unemployment and needs of balance sheet repairs, households could cut discretionary consumption even more sharply.

Under these assumptions, the GDP loss during the six months of the pandemic would amount to around five percent in the UK. This means that GDP growth in 2010 would be at least as bad as in 2009.

However, and although once the pandemic is over the economic bounce back would likely be less sharp than post-SARS, chances are that, by 2011, GDP growth could be above our baseline forecast and the economic loss would be gradually recouped within around three to four years. CPI inflation would likely turn negative for a few months but would rise as pent-up demand is realised.

There is a risk that swine flu tips the UK and the world economy into deflation as the pandemic would hit at a time when businesses and banks are still reeling from the economic crisis.

Rather than catching up on postponed spending, households may raise savings for a longer time, while companies that are already fragile after the recession may succumb to this new shock.

We estimate that under such a scenario the UK and world economies would fall into deflation. UK CPI inflation would fall to around minus one percent throughout 2010-12 and UK GDP growth next year could be as low as minus seven-and-a-half percent. With the government budget deficit already at sky-high levels and the Bank of England’s interest rates pretty much at zero, there is little that public authorities could do to try to buffer the impact.

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