Chapter 10: The COVID economic crisis

See in recap if I actually need to know this

What are the effects of a decrease in output on the affected sector (directly impacted by covid) and the non-affected sector (not directly impacted by covid)?

When the govt imposes a lockdown, the affected sector experiences a drop in output (e.g. restaurants closing or limiting capacity), reducing supply and demand for goods. The new equilibrium shifts as the IS curve for the affected sector moves leftward.

The non-affected sector faces changes in demand due to several factors: If goods from the two sectors are substitutes, demand for the non-affected sector increases, shifting the IS curve to the right. If workers in the affected sector lose jobs, their reduced income decreases demand for goods in the non-affected sector, shifting the IS curve to the left. Uncertainty causes saving, leading to reduced consumption and shifting the IS curve left.

What could fiscal policy do to address the issue of decreased output?

Fiscal policy cannot directly increase output in the affected sectors (like restaurants and airlines), but it can support firms and workers to prevent bankruptcies and alleviate hardship. It can also help reduce demand spillovers in the non-affected sector by providing income to unemployed workers, thus mitigating a decrease in demand and output. Fiscal policy prevents the IS curve from shifting too far left. This helps to stabilise the economy, though output in the non-affected sector may still fall short of the natural level, resulting in a recession, but less severe than without policy intervention.

What could monetary policy do to address the issue of decreased output?

Monetary policy can stimulate demand by lowering interest rates, which shifts the LM curve downward, increasing demand in the non-affected sector. Ideally, this can help maintain output at its natural level, but in practice, the policy response may still lead to lower output in both sectors, resulting in a significant recession.

What was the real world response?

US: Fiscal (subsidies and loan guarantees) and monetary (reducing interest rates and engaging in market interventions) policies were implemented.

EU: similar policies were implemented, though there was limited room to reduce interest rates further. These measures helped prevent a catastrophic collapse in output, but the decline remained severe. In the second quarter of 2020, output fell by 10-20% compared to the end of 2019.

What were the real world sectoral impacts?

Sectoral impact: The pandemic's impact varied across sectors. Employment in directly affected sectors (like restaurants and airlines) fell by about 50%. In sectors indirectly affected by reduced demand (such as furniture and automobiles), employment also decreased significantly. However, sectors that benefited from the lockdown, such as food and delivery services, saw little to no decrease in employment, and some even experienced growth.

After lockdowns ended, many businesses reopened leading to a significant increase in employment and activity. Why may this recovery slow?

1. Mechanical recovery: Much of the recovery is due to firms reopening and rehiring workers. This effect will diminish over time.

2. Uncertainty can dampen consumer spending and investment

3. Firms that survived using loans may accumulate debts and face bankruptcy

What macroeconomic policy recommendations does the textbook give?

1. Policy should distinguish between ‘post-lockdown’ phase and ‘post-vaccine’ phase

2. Target aid to businesses that can return to normal post-vaccine (e.g., restaurants and hotels), while also offering support to those facing permanent changes (e.g., airlines).

3. Small- and medium-sized businesses should be allowed to restructure their debt rather than closing down, to ensure they can survive

4. Policies should give unemployment support

What may the economy look like post-vaccine?

• Economic Reallocation: A shift in the economy, (eg telework). This change will affect firm organisation, productivity, urban planning, transportation, and inequality.

• Increased Public Debt: COVID-related spending has significantly raised public debt. In the U.S., it is projected to rise from 79.2% of GDP in 2019 to 104% by the end of 2021. But low interest rates may mitigate the risks.

• Central banks have expanded their balance sheets by buying assets to stabilise financial markets. The U.S. Fed’s liabilities increased from $4.1 trillion to $7 trillion, and the European Central Bank’s from €4.6 trillion to €6.5 trillion. Although some fear inflation from this increase in money supply, it is unlikely to lead to high inflation.