Working Paper: CEPR ID: DP14777
Authors: Andrés Velasco; Roberto Chang; Luis Felipe Céspedes
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.
Keywords: No keywords provided
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 |
|---|---|
| labor shedding (J63) | productivity (O49) |
| low expected productivity (D24) | low collateral value (G33) |
| low collateral value (G33) | restrict borrowing (H74) |
| restrict borrowing (H74) | low productivity (O49) |
| low expected productivity (D24) | restrict borrowing (H74) |
| adverse shocks (E32) | magnified effects on unemployment and asset prices (E44) |
| pessimistic expectations (D84) | bad equilibrium (D59) |