Covid-19 coronavirus and macroeconomic policy

Abstract

As we write, the Covid-19 coronavirus is spreading throughout the globe. Besides its impact on public health, this coronavirus outbreak is likely to have significant economic consequences. The consensus is that the virus will cause a negative supply shock to the world economy, by forcing factories to shut down and disrupting global supply chains (OECD, 2020). But how deep and persistent is this supply disruption going to be? Will aggregate demand be affected? What is the appropriate monetary policy response? What about fiscal policy? These questions are currently at the center of a heated debate. Tackling these questions requires taking into account a range of scenarios. In this short note, we consider the (hopefully pessimistic) possibility that the supply disruption caused by Covid-19 will be severe and persistent, potentially lasting beyond the end of the epidemic. To be clear, we have no reasons to believe that this scenario is more plausible than other - more optimistic - ones. It might very well be, in fact, that the virus will end up causing a relatively mild and short-lived global recession, followed by a V-shaped recovery (Wren-Lewis, 2020). Given the huge uncertainty surrounding the future evolution of the epidemic, however, it is useful to workout the macroeconomic implications of more pessimistic scenarios. To do so, we employ a very simple analytic framework. We highlight three results. First, the spread of the virus might depress global demand. Second, a supply-demand doom loop might take place, amplifying the supply disruption directly caused by the virus. Third, this epidemic might make the global economy vulnerable to stagnation traps, that is episodes of low growth and high unemployment driven by pessimistic animal spirits. While monetary easing can help mitigate the drop in global demand, our analysis suggests that aggressive fiscal policy interventions to support investment will be needed to push the global economy out of stagnation. Before starting, one disclaimer is in order. Both the model and the results that follow draw heavily on existing works. In particular, the results in Sections 1 and 2 are based on Galí (2009) and Lorenzoni (2009). Sections 3 and 4 are instead based on Benigno and Fornaro (2018). The purpose of this note is to apply these existing insights to the coronavirus epidemic.