Capital Markets & IT - lakyara May 2020
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- The economic shock from the coronavirus pandemic is fundamentally different from a recession driven by a drop in demand. Specifically, it is a supply shock triggered by a shutdown of economic activity imposed to prevent the community transmission of the virus.
- A demand shock resulting from a decline in demand can be reversed or at least mitigated by policies to boost demand, but such measures are impotent in the face of a supply shock like the current one.
- The coronavirus shock has led to an economic crisis in which businesses—following government recommendations—have fully or partially shut down their operations, resulting in a loss of sales for companies and of wages and jobs for employees. If nothing is done to address this and large numbers of business exits or failures produce a surge in unemployment, Japanese GDP may fall even further, plunging the nation into a full-fledged depression.
- The government must provide immediate cash assistance to affected businesses and individuals. In particular, a moratorium on taxes and other payments to the government is needed as soon as possible, along with cash compensation for forgone income and business losses.
- 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.
- Minimizing physical contact between people is essential to combatting the spread of COVID-19, as we have yet to develop immunity to the virus. This has led many countries to enact “social distancing” policies that include stay-at-home orders, business shutdowns, and lockdowns of urban areas.
- Choosing not to implement social distancing policies removes the constraint on economic activity but also increases the risk that infections will surge and overwhelm the healthcare system. While social distancing slows economic activity and thereby entails huge costs, it prevents the virus from spreading and can therefore help to prevent a collapse of the medical system.
- Social losses due to the coronavirus can be roughly divided into two categories: the decline in GDP due to reduced economic activity and the loss of human life.
- In this report, I introduce two papers undertaking a cost-benefit analysis of social distancing measures in the United States. These papers suggest that social losses due to social distancing policies are less than the losses that would be incurred if no such policies had been implemented. The papers estimate the economic value of social losses avoided via these policies (i.e., the net benefits) at around USD5-8 trillion.
- In Japan as well, the government declared a state of emergency for seven prefectures on April 71) and requested that people in the affected areas stay home and that businesses shut down. These social distancing policies can be expected to minimize social losses by reducing the number of infections. However, the government needs to enhance their effectiveness by providing early and adequate economic assistance to businesses and households.