Scarring Body and Mind: The Long-Term Belief-Scarring Effects of Covid-19

Abstract

The largest economic cost of the COVID-19 pandemic could arise if it changed behavior long after the immediate health crisis is resolved. A common explanation for such a long-lived effect is the scarring of beliefs. We show how to quantify the extent of such belief changes and determine their impact on future economic outcomes. We find that the long-run effect of the COVID crisis depends crucially on whether bankruptcies and changes in habit make existing capital obsolete. A policy that avoided most permanent separation of workers from capital could generate a much larger benefit than originally thought, that could easily be 180% of annual GDP, in present value.

Keywords: COVID-19, coronavirus, rare events, tail risk, belief-driven business cycles

JEL Classification: D84, E32