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The COVID Crisis and ”Freezing the Economy” – Supply and Demand Shocks�

Kevin Krajnc, Patrik Egger,

Nikola Nikolić, Polina Gordienko,

Robin Korametho, Sarolta Bakó,

Stefan Schwingenschlögl

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COVID-19 Economic Crisis

Keeping the lights on: Economic medicine for a medical shock," by Richard Baldwin

The COVID-19 economic crisis is unlike any other we've faced before

The underlying shock has hit all the G7 nations and China at the same time.

By 31st January 2020, every G7 nation had at least one case.

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Three types of economic shocks

Impact of the disease on productivity and employment

6% of the US workforce reported being unable to work at some point due to illness

Domestic and international demand shocks, as well as supply chain disruptions

it is estimated that global output decreased by approximately 33%

Expectations of uncertainty leading to reduced consumer and business spending

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Purchasing Managers' Indexes

New orders, Inventory levels, Production, Supplier deliveries, Employment

Eurozone and UK dropped to 16

US and China stopped at around 26

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Impact on the economy

Disruption of the circular flow of income

Households

Businesses

International Trade

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Government Response Strategies

Prioritze quick and decisive action to sustain economic activity

Prevent unnecessary bankruptcies and support businesses

Ensure people have means to continue spending

Support self-quarantine efforts

Other existing proposals:

Benassy-Quéré's plan

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Flattening the Pandemic and Recession Curve

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Flattening the Pandemic Curve

Fatality rate – 2%
1% of Population – 76mil
Shaded red area

Flattening the curve by promoting health practices
Taiwan, Singapore, or the Chinese regions outside Hubei
Short-run public health policy.

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What if health authorities do the right thing?

Flattening the infection curve inevitably steepens the macroeconomic recession curve
China and Italy
Sudden stop- dramatic plunge in production and trade

"A perfect world, but"

containment measures reduce economic activity by 50% for one month and 25% for another month
decline in annual output growth - 6.5% (10%)

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Are we about to witness a downturn that could dwarf the `Great Recession`?

Much larger numbers! Why?

Unemployment rate

A modern economy is a complex web of interconnected parties: employees, firms, suppliers, consumers, banks and financial intermediaries…

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"A real danger is that the virus mutates and infect our economic system even as we manage to root it out of our bodies"

Some will ignoring self-isolation instructions
Self-isolation ---> Impulse to cut down spending ---> Firms get less income and start cutting down costs ---> Shedding of workers ---> Banks cut lending
Panic Mode

The economy too faces a ‘flatten the curve’ problem (Irony!)

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Flattening the Recession Curve

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Priority Measures for Economic Support

Priority (a): Ensure job retention and income stability for workers.
Priority (b): Provide support to prevent firm bankruptcies, including financial assistance and eased borrowing terms.
Priority (c): Safeguard financial system to prevent cascading crisis effects.
Timing: Urgency of implementing economic measures during shutdown phase.
2 months at 75% production would cost 5% of annual output
Fiscal Consideration: Acknowledgement of high fiscal cost but necessity in preventing severe economic collapse.

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Proposals for Economic Stability

Borrowing Rates: Highlight historically low rates, conducive to borrowing for economic support. Even a 10% increase in debt-GDP only increases annual interest costs by 0.1% of GDP
Proposal for Eurozone: Consider issuance of Eurobond to finance health expenditures and prevent economic dislocation.
Alternative: Coordinated sovereign debt issuance (10-20% of GDP) with expanded Quantitative Easing by ECB.
Global Perspective: Recognize need for financial assistance to developing and emerging countries to prevent future fiscal solvency issues and aid global economic stability.

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Coronavirus and macroeconomic policy

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Impact of covid on aggregate demand

The pandemic led to unemployment
But how?
What is similar between the covid situation and the as discussed potential rate hikes?
How did the ECB react?

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Impact of covid on aggregate demand

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7 key points

Initial shock and demand reduction
Income uncertainty and consumer behavior
Supply disruption and production constraints
Investment contraction and business confidence
Goverment policy responses
International trade and external demand
Long term structural changes

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The supply-demand doom loop

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How do we break free from this cycle?

Increasing the money supply through lowering interest rates

Central Bank makes it easier to borrow money

Companies would invest more

People would feel better about their future incomes

Leading them to spend more

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Animal spirits and stagnation traps

Animal spirits: describe how people arrive at financial decisions, including buying and selling securities, in times of economic stress or uncertainty, which captures the emotional and psychological aspects of decision-making

Stagnation traps: occur when pessimistic expectations lead to persistent or even permanent slumps characterized by high unemployment and weak growth

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Animal spirits and stagnation traps

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Fiscal policy as solution

The government implements policies

To incentivize
Directly support firms’ investments endeavours

Investment subsidies
Initiation of public invesment programs

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GDP Forecasts 2024/25�Austria, USA, Japan

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Austria – WIFO

Austrian Institute of Economic Research. March 22, 2024

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USA – The Conference Board

The Conference Board. April 11, 2024

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Japan – Bank of Japan

Bank of Japan. April 26, 2024

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Comparison – Austria, USA, Japan�

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Comparison – OECD, IMF�

OECD. February 2024; International Monetary Fund. April, 2024

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Sources