The Macroeconomics of a Pandemic: A Minimalist Model

Velasco, Andrés, Roberto Chang and Céspedes, Luis Felipe
Authors registered in the RePEc Author Service: Luis Felipe Cespedes

No 14777, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We build a minimalist model of the macroeconomics of a pandemic, with two essential components. The first is productivity-related: if the virus forces firms to shed labor beyond a certain threshold, productivity suffers. The second component is a credit market imperfection: because lenders cannot be sure a borrower will repay, they only lend against collateral. Expected productivity determines collateral value and, in turn, collateral value can limit borrowing and productivity. Adverse shocks can be subject to large magnification effects, in an unemployment and asset price deflation doom loop. Multiple equilibria may also occur, and pessimistic expectations can push the economy to a bad equilibrium with limited borrowing and low employment and productivity. The model helps select policies to fight the effects of the pandemic. Traditional expansionary fiscal policy has no beneficial effects, while cutting interest rates has a limited effect if the initial real interest rate is low. By contrast, several unconventional policies, including wage subsidies, helicopter drops of liquid assets, equity injections, and loan guarantees, can keep the economy in a full-employment, high-productivity equilibrium. But such policies are fiscally expensive, so their implementation is feasible only with ample fiscal space or emergency financing from abroad.

Date: 2020-05
New Economics Papers: this item is included in nep-fdg and nep-mac
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Citations: View citations in EconPapers (15)

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Working Paper: The Macroeconomics of a Pandemic: A Minimalist Model (2020)
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