With the pandemic news moving quickly Matty convinced me to spend more time on Twitter to keep up with the news (my account is here if you want to follow). I saw some interesting links regarding the economics of COVID-19 which I would like to share and comment on – and I decided to run through all these points on one post .
Here are the topics I cover. Each is titled, so you can scroll down if you are only interested in one these:
- A jump in the CPI even as demand falls? Consumer prices may rise in the short term, even as expenditure is falling – and this “price level” change is not necessarily indicative of a supply shock.
- How to visualize the “timeline” of COVID-19 and the economic elements.
- What does ECON101 think?
- On humility: During the health crisis public health experts are the primary people able to analyse the issue and help with policy. Economists main role remains defining the trade-offs, but not deciding policy.
I don’t want to state what policies I think are good and which are bad. Instead I just want to share these points, as they are ideas I am using to understand what different policies might be trying to achieve as an interested person.
CPI, shortages, and demand shocks
COVID-19 is creating shortages in situations where production has not been influenced. Stating this, and noting as Kopczuk does that some prices are adjusted upwards, make it sound like a positive demand shock.
Let’s see if this is the case. If it was I would have been wrong, and a lot of the present international policy discussion would also be wrong. But instead, I think there is a negative demand shock and the lift in demand for these goods now is associated with:
- people shifting consumption of these items forward for fear of pandemic.
- people also avoiding other types of activities (eg cafes).
If prices are sticky downwards, the composition of that shock means we may observe the price level may go up, even though overall expenditure is not!
Furthermore, in the very near term that lost other activity remains lost, while the activity that is shifted forward will leave an additional hole in demand.
So is it true that discretionary purchases (as opposed to things that are seen as essential) have dropped – in the US lets look at restaurant bookings.
And what about if we stop talking about individual items and ask about market expectations of inflation and interest rates on the basis of COVID-19? For this the next two tweets give a strong indication that there is a large negative demand shock.
How to visualize the “timeline” of COVID-19 and the economic elements.
In my first post on COVID-19 I discussed the idea of two separate shocks – the demand shock associated with the pandemic overseas, and the supply and demand shocks associated with the pandemic arriving onshore.
When discussing the specifics of these shocks, the potential importance of business continuity was raised.
The important distinction was between when the pandemic is here (activity needs to be lower due to supply shock) and when it is offshore (when it is mainly a demand shock). If it stays offshore (unlikely) we would need to balance the above facts when making a monetary policy decision. When it comes here we will have a recession, but that is because some income is “lost” due to us all being off sick – that doesn’t mean monetary or fiscal policy can bring it back, instead the question is about who bears the burden of that loss.
However, I think the following tweet that shows a stylised timeline of these shocks is really useful for helping think through these issues.
That tweet thread has further discussion based on tweeting economists – but to me that graph is a powerful tool to guide thinking.
But this also raises a question, is the agreement among economists that COVID-19 will cause a recession due to the expected loss from “protecting health” (e.g. closing businesses, social distancing) or because of a demand shock?
To my mind the importance of the demand shock can’t be ignored – given what has happened to the yield curve (as noted above).
But even if there is no negative demand shock and the economy does rebound we would expect to see a recession from a pandemic. Preventing a “technical recession” is not always what we want to do – especially when there is a trade-off for other aspects of wellbeing (health).
The current Harvard intro economics lecturer noted the following.
Greg Mankiw is the former intro economics lecturer at Harvard. The Mankiw post is here.
In the post Mankiw repeats the recession point above but also pushes another important point – this is about social insurance (eg payments made to people who suffer from the consequences of COVID-19).
Let’s think about a pandemic as a natural disaster. This is unexpected and either is uninsurable, or individuals act as if they expect the broad community to share in the cost. As a result, any policy response is about, in some sense, who pays the cost of this disaster. There are two elements here i) fairness, and ii) “coordination failures”.
I asked Matty if he agreed as he also teaches intro economics. He said he did, although he said in class he would also note an additional factor. If monetary policy wasn’t able to stabilise demand, then they might need to coordinate with fiscal decision makers.
So I think that is a large enough sample of intro micro lecturers to call this a consensus on the importance of social insurance!
The social insurance policies are the ones that determine how the burden of the shock is distributed, and insofar as they help with coordination failures (eg increasing the ease with which people can take sick leave) they can also increase efficiency.
There is more discussion on the full thread.
I agree with Alfredo, as I noted here:
What becomes much more important for policy is identifying coordination failures.
The clearest example is with regards to how to stop or slow the spread of the virus, as a communicable disease implies there are externalities from an individual’s choice.
Let’s say employees and employers are averse to using sick leave – but not using it increases the chance of transmission which has an externality. Do we need to advertise the importance of taking leave? At what point are schools and public offices closed? When are non-essential services closed to limit the spread of the virus?
These are public health issues, where what might be best for the individual has severe consequences for the other individuals around them – and so restrictions could be necessary. But how to judge that?
No GDP figure, or appeal to demand and supply can inform us on that question – so when the virus reaches here the government’s main role is in making judgement calls about these trade-offs. And the some of the best advice will come from epidemiologists and public health professionals regarding these specifics, not so much economists.
Allowing the public health authorities to manage public health, and then deal with the allocation issues that come from it is preferable than just trying to “protect the economy” as some US presidents have been suggesting – and some businesses closer to home have potentially been implying!