Putting the economic shock of the coronavirus in context (2) Why cash compensation for income and business losses is needed
May. 19, 2020
In the first report in this series (“Overview using a macroeconomic model”), I used a simple AS-AD model to show that the economic shock from the coronavirus is a supply shock caused by supply-side shutdowns, and that the kinds of measures taken during an ordinary recession to boost aggregate demand would have no effect.
In this report, we discuss a paper presenting a model for a supply shock that elicits a drop in aggregate demand. The paper demonstrates that in a supply shock triggered by the shutdown of an industry, workers who lost their jobs and businesses that failed will consume less in other sectors. As such, a supply shock in one sector will ultimately reduce demand in other sectors.
The paper also argues that effective tools for addressing such a shock include financial assistance to prevent corporate bankruptcies and direct cash handouts to workers in the industries that shut down. Without these measures the supply shock will trigger a further decline in aggregate demand, amplifying the initial shock.
There is also the concern that if jobs are lost because businesses close their doors, it will take an extended period of time for productivity to rebound and for the broader economy to recover from the shock. The paper concludes that governments need to administer direct and immediate fiscal stimulus to support businesses and preserve jobs.