Working Paper: NBER ID: w27228
Authors: Luis Felipe Céspedes; Roberto Chang; Andrés Velasco
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; 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.
Keywords: Macroeconomics; Pandemic; Productivity; Credit Market Imperfections; Policy Measures
JEL Codes: E6; F4; H8
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) |
| Labor Retention (J63) | Productivity (O49) |
| Low Expected Productivity (D24) | Low Collateral Value (G33) |
| Low Collateral Value (G33) | Limited Borrowing Capacity (G51) |
| Limited Borrowing Capacity (G51) | Lower Employment (J63) |
| Limited Borrowing Capacity (G51) | Lower Productivity (O49) |
| Adverse Shocks (E32) | Reduced Access to Credit (G21) |
| Reduced Access to Credit (G21) | Exacerbated Unemployment (J64) |
| Reduced Access to Credit (G21) | Productivity Losses (D24) |
| Lenders' Expectations (G21) | Asset Values (G32) |
| Low Asset Values (G19) | Less Lending (G21) |
| Less Lending (G21) | Labor Shedding (J63) |
| Pessimistic Expectations (D84) | Low Productivity Equilibrium (D59) |
| Optimistic Expectations (D84) | Higher Asset Values (G19) |
| Higher Asset Values (G19) | Increased Borrowing (H74) |
| Increased Borrowing (H74) | Employment Support (J68) |