Working Paper: CEPR ID: DP14614
Authors: Andrés Velasco; Roberto Chang
Abstract: The Covid-19 pandemic has motivated a myriad of studies and proposals on how economic policy should respond to this colossal shock. But in this debate it is seldom recognized that the health shock is not entirely exogenous. Its magnitude and dynamics themselves depend on economic policies, and the explicit or implicit incentives those policies provide. To illuminate the feedback loops between medical and economic factors we develop a minimal economic model of pandemics. In the model, as in reality, individual decisions to comply (or not) with virus-related public health directives depend on economic variables and incentives, which themselves respond to current economic policy and expectations of future policies. The analysis yields several practical lessons: because policies affect the speed of virus transmission via incentives, public health measures and economic policies can complement each other, reducing the cost of attaining desired social goals; expectations of expansionary macroeconomic policies during the recovery phase can help reduce the speed of infection, and hence the size of the health shock; the credibility of announced policies is key to rule out both self-fulfilling pessimistic expectations and time inconsistency problems. The analysis also yields a critique of the current use of SIR models for policy evaluation, in the spirit of Lucas (1983).
Keywords: Crisis; COVID-19; Pandemics
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| economic variables and incentives (P42) | individual decisions to comply with public health directives (D70) |
| individual decisions to comply with public health directives (D70) | speed of virus transmission (C69) |
| public health measures (I14) | costs associated with lockdowns (J32) |
| expectations of future expansionary macroeconomic policies (E60) | speed of infection (C41) |
| economic choices regarding work and health (J29) | dynamics of contagion (C69) |
| expectations about future policies (D84) | compliance and contagion dynamics (E44) |