The Macroeconomics of a Pandemic: A Minimalist Framework

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

Working Papers from University of Chile, Department of Economics

Abstract: We build a minimalist framework to analyze 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; in turn, collateral value can limit borrowing and productivity. As a result, adverse shocks have large magnification effects, in an unemployment and asset price deflation doom loop. There may be multiple equilibria, so that pessimistic expectations can push the economy to a bad equilibrium with limited borrowing and low employment and productivity. The model helps identify 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. Such policies can be fiscally expensive, so their implementation is feasible only with ample fiscal space or emergency financing from abroad. We provide macroeconomic evidence consistent with the mechanisms in our model.

Pages: 40 pages
Date: 2020-09
New Economics Papers: this item is included in nep-cwa and nep-mac
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Citations: View citations in EconPapers (1)

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Journal Article: The macroeconomics of a pandemic: A minimalist framework* (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:udc:wpaper:wp504

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