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The macroeconomics of pandemics: A progress report

Michael Burda (HU Berlin)


In three short months, the world has quickly re-learned lessons long forgotten: Pandemics have enormous macroeconomic consequences. Upwards of 100 million persons are estimated to have died in the Spanish Influenza (1918-1919), or 3% of the world’s population. Because GDP accounts and labor force surveys didn’t exist and most of the world was in the throes of conflict, the true economic costs of that episode may never be known. In any event, the current corona pandemic is hitting the economy hard: Output in the US is forecast to decline by more than 5% in 2020, in the EU by 8%, while unemployment is soaring. Macroeconomics deals with systemic influences over our economic well-being. What does it have to say about the mechanisms of pandemics?

Pandemics adversely affects both aggregate demand and supply of goods and services. On the demand side, households restrict consumption. An increase in perceived likelihood of income or job loss induces most people to save more. Additionally, people avoid shopping in public places and consuming goods in the presence of others – more often than not, consumption involves a social element, whether desired (soccer matches, theater, concerts, clubs) or not (shopping, dining out, air travel). Governments reinforce this decline by mandating social distancing or lockdown to reduce disease spread. Firms cancel or postpone investment plans in the face of sales declines. The demand for energy and raw materials falls. Some countries close borders and even restrict trade. Governments are trying to boost aggregate demand by providing liquidity to firms and short-time work payments, increasing spending and cutting taxes. Unable to reduce interest rates, central banks are purchasing government and private debt in the open market, stimulating demand for those assets and providing financial markets with funds for liquidity-strapped entities. In spite of these efforts, demand is contracting around the world.

On the supply side, workers stay home because they become ill, are afraid of doing so, or must care for sick family members. Supply chains are interrupted, leading to shortages. Banks and financial institutions that supply liquidity to the real economy may restrict lending. Firms suffering sharp loss of sales may close and destroy costly organizational and relational capital. Unemployed workers cannot easily travel to jobs. These supply-side problems could lead to higher inflation when economic conditions normalize.

The unique defining feature of the current macro crisis lies in externalities involving consumption, production, and social relations. Actions of agents can affect the utility and efficiency of others in ways that are not mediated by markets, leading to suboptimal outcomes. In a truly interdisciplinary spirit, recent theoretical research has combined macroeconomic reasoning with the canonical “SIR” epidemiological model first proposed in the late 1920s (Kermack and McKendrick 1927, Atkeson 2020, Grimm et al. 2020). Eichenbaum, Rebelo and Trabandt (2020) focus on consumption and labor supply as accelerants to disease spread. Garibaldi, Moen, and Pissarides (2020) investigate general interactions well-understood from labor matching models and the impact of individual decisions on aggregate outcomes. In both models, decentralized equilibria are inferior to the social planner’s optimum, yet purposeful, self-interested behavior does shift agents away from activities that raise infection risk. Focusing on consumption, Krueger, Uhlig and Xie (2020) explore complementarity and substitution among classes of goods with different infection risk. Substitution may ameliorate the rate of infection, yet is unlikely to bring about the socially optimal outcome. Many questions remain open for future inquiry. What is ease of sectoral supply readjustment away from infectious forms of consumption to their substitutes – and do these substitutes even exist? Is the externality more prevalent in consumption or in production, or even between the two? What is the role of durability of goods? Of working in contact-intensive sectors, or essential services? How will the global value-added chain adapt?  Is there an option value of keeping sectors open?  

An unavoidable question in the current discussion is the tradeoff between saving human lives on the one hand, and the loss of economic activity due to combating disease spread on the other (plus indirect loss of life associated with unemployment, income loss, stress, etc.). Alvarez, Argente and Lippi (2020) and Bethune and Korinek (2020) explore optimal policy in light of these aspects, while Glover, Heathcote, Krueger and Ríos-Rull (2020) evaluate the US lockdown since April of this year. Virologists seem to agree that if all could isolate for 3-4 weeks, the pandemic would wither and die on the vine. In reality, essential services and enforcement difficulties lead to inevitable contacts, so this is impossible. Lacking a vaccine, moving rapidly towards herd immunity has steeply rising costs in lives lost; flattening the curve implies higher loss of GDP. These “health versus wealth” questions are not new to economics. The more difficult question is a distributional one: between an additional year of life for an 80 year-old against a lifetime of degraded economic prospects for a younger person, with associated reduced long-run longevity as a result.

Alvarez, F, Argente, D and Lippi, F (2020) A simple planning problem for Covid-19 lockdown. Covid Economics 14:1-32.

Atkeson, A (2020) What will be the economic impact of Covid-19 in the US? Rough estimates of disease scenarios. NBER Working Paper 26867.

Bethune, Z and Korinek, A (2020) COVID-19 infection externalities: Pursuing herd immunity or containment? Covid Economics 11, 29 April 2020: 1-34.

Eichenbaum, M, Rebelo S and Trabandt M (2020) The Macroeconomics of Epidemics, NBER Working Paper No. 26882, March.

Glover, A, Heathcote, J, Krueger, D and Ríos-Rull, V. (2020) Health versus wealth: On the Distributional Effects of Controlling a Pandemic, mimeo, April.

Grimm, V, Mengel, F and Schmidt, M (2020) Extensions of the SEIR Model for the analysis of tailored social distancing and tracing approaches to cope with COVID-19. International Journal of Infectious Diseases 93:201–204.

Garibaldi, P, Moen, E and Pissarides, C (2020) Modelling contacts and transitions in the SIR epidemics model. Covid Economics 5:1-20.

Kermack, W O and McKendrick A G (1927) A contribution to the mathematical theory of epidemics. Proceedings of the Royal Statistical Association 115:700-721.

Krueger, D, Uhlig, H and Xie, T (2020) Macroeconomic dynamics and reallocation in an epidemic. Covid Economics 5:21-78.

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