Supply-led Deflation due to COVID-19 cannot be solved by liquidity easing

There have been several days of global plummets of stock markets in the past few weeks, including Feb 28, Mar 9, and Mar 13 (Hong Kong Time) as shown in the figures below:

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Figure 1 Global Stock Prices on Feb 28 (HK Time). Source:
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Figure 2 Global Stock Prices on Mar 9 (HK Time). Source:
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Figure 3 Global Stock Prices on Mar 13 (HK Time). Source:

On Feb 28, the S&P-VIX was at 39.16, even though the S&P 500 fell 4.42%. (Figure 1)

Then on Mar 9, the S&P-VIX increased to 41.94 when the whole world toppled. For example, Nikkei 225 fell 5.38%, and the Hang Seng Index fell 4.68%. (Figure 2)

Mar 13 marked a Black Friday (or Thu in US time) as Dow 30 and S&P 500 fell 9.99% and 9.51%, which are one of the biggest falls since the 1980s. The S&P-VIX surged to 69.08. It also broke several records this week, including the twice triggers of the ‘circuit breaker’, i.e. a temporary suspension of the US stock market.

Many governments have immediately launched QE/OT/REPO measures and/or cut interest rates to increase market liquidities. It seems that we are approaching a global negative nominal interest rate regime very soon.

However, it is believed that these liquidity-increasing measures may not be effective in tackling the coming recession and deflation caused by the COVID-19.

In the past, most of the financial crises were caused by a demand-led recession. It is in line with Irving Fisher’s (1933) Debt-Deflation Hypothesis (DDH).

Fisher developed the hypothesis to explain the cause of the Wall Street Crash in 1929 and the ensuing Great Depression.

A demand-led recession, according to the DDH, is triggered by a state of over-indebtedness. “Debt liquidation leads to distress selling.” In other words, when people have too many debts, people would have to cut their consumption.

Minsky (1982) and Bernake (1983) further extended Fisher’s DDH to explain asset price plummets and wide-spread bankruptcy. Both would further lead to contractions in consumption and investment demands.

Thus, it may be sensible to deal with these demand-led recessions by increasing liquidity. However, the current imminent global recession due to COVID-19 does not seem to be a demand-led recession, but a supply-led one, or both.

Certainly, we are in an unprecedentedly high level of debts, no matter it is personal debts, corporate debts, or national debts. Yet, this time, it is not people who do not have enough liquidity to spend, it is a disruption of the supply chain, due to the closure of factories, closure of offices, closure of transportation, …

When products cannot be produced on time, services cannot be provided to satisfy demand, no matter how liquid the market is, people still cannot spend.

Since it requires quarantines, social distancing, isolations-for-14-days and travel bans to stop the spread of the pandemic of COVID-19, large-scale gatherings are stopped, for example, NBA and soccers matches are suspended. Many governments encourage or even enforce a mandatory suspension of social gatherings or even a complete lockdown of cities (in some extreme cases, people are not allowed to leave their homes for months). When you have to stay at home for months, it becomes almost impossible for people to spend more than the basic necessities. Retail markets, including shops, restaurants, and cafes, are hard hit. Worse still, when some important cities are locked down, their roles in the globalized supply chains could not be performed. It disrupts the supply of products or services. If the pandemic lasts any longer, many products may be out of stock.

Certainly, the supply chains can be switched. In fact, many factories are moving out of the infected areas to resume production, or new production lines are immediately built to supplement the supply. But when it becomes pandemic, it may not help move the production from one place to another, as anywhere is now infection-prone.

The retail industry, entertainment industry, travel industry, and event industry are particularly vulnerable, as they normally could not switch from one place to another, and once they lose the businesses on a day, they could not get it back on another day. For example, we could not suspend NBA matches in the first half of a year, and double the number of matches in the second half of a year to get the money back. If a movie could not be shown in the holidays, its income would be much less even if it could be shown later.

These industries are expected to encounter substantial losses during the pandemic. If they are in heavy debts, large-scale bankruptcies can come. The unemployment rate would then be increased. People would spend less, this would lead to a traditional demand-led recession (debt-deflation). It may be solved by liquidity easing until the bubble burst.

But this time due to the disruption of the supply chains, products and services cannot be provided on time. When factories and organizations are forced not to produce or provide services, event organizers are forced to cancel all kinds of events, people are forced not to spend more, no matter how liquid the market is or how willing to spend the consumers are. This kind of supply-led recession cannot be solved by liquidity easing.


Bernanke, B. (1983) ”Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression”, American Economic Review, Vol. 73(3), June 1983, p. 257–76.

Fisher, I. (1933) “The Debt-Deflation Theory of Great Depressions,” Econometrica 1 (4): 337–57

Minsky, H. (1982) ”Debt-Deflation Processes in Today’s Institutional Environment”, Banca Nazionale del Lavoro Quarterly Review, December.

ecyY is the Founder of Real Estate Development and Building Research & Information Centre REDBRIC

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