The Macroeconomics of a Pandemic: A Minimalist Model

28 Pages Posted: 28 May 2020

See all articles by Luis Felipe Céspedes

Luis Felipe Céspedes

affiliation not provided to SSRN

Roberto Chang

Rutgers University, New Brunswick/Piscataway - Faculty of Arts and Sciences-New Brunswick/Piscataway - Department of Economics; National Bureau of Economic Research (NBER)

Andrés Velasco

Harvard University - Harvard Kennedy School (HKS); National Bureau of Economic Research (NBER)

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Date Written: May 2020

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.

Suggested Citation

Céspedes, Luis Felipe and Chang, Roberto and Velasco, Andrés, The Macroeconomics of a Pandemic: A Minimalist Model (May 2020). CEPR Discussion Paper No. DP14777, Available at SSRN: https://ssrn.com/abstract=3612845

Luis Felipe Céspedes (Contact Author)

affiliation not provided to SSRN

No Address Available

Roberto Chang

Rutgers University, New Brunswick/Piscataway - Faculty of Arts and Sciences-New Brunswick/Piscataway - Department of Economics ( email )

75 Hamilton Street
New Brunswick, NJ 08901
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Andrés Velasco

Harvard University - Harvard Kennedy School (HKS) ( email )

79 John F. Kennedy Street
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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