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Macroeconomic policies and the pandemic-driven recession

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  • Costa Junior, Celso J.
  • Garcia-Cintado, Alejandro C.
  • Junior, Karlo Marques

Abstract

We build a three-country DSGE model to address the economic fallout from the COVID-19 shock. First, three different scenarios –optimistic, baseline and pessimistic– are drawn where economic authorities are assumed to not react to the disturbance. We find that the pandemic brings about a prolonged economic depression in the latter scenario –the most realistic one–, as GDP and hours worked fall by 20% (from trend) and they never recover their pre-crisis levels over the span of time studied. We then move on to analyze the effectiveness of conventional fiscal and monetary policy tools in curbing the recessionary consequences of the pandemic. The most powerful instruments are government purchases and expansionary monetary policy, although these two measures come with some trade-offs. In addition, we explore how a binding zero lower bound (ZLB) that renders conventional monetary policy ineffective can affect our findings. We show that the lower constraint deepens the recession caused by the pandemic, primarily because the central bank cannot lower the policy rate further, and because fiscal policy tightens in order to ensure government debt sustainability. Naturally, we next ask ourselves what would happen in this context did the monetary authority rely on unconventional monetary policy to try to dampen the recessionary consequences of the pandemic. Our results reveal that quantitative easing (QE) prevents private consumption, inflation, and to a much lesser extent, output from falling as much due to the shock.

Suggested Citation

  • Costa Junior, Celso J. & Garcia-Cintado, Alejandro C. & Junior, Karlo Marques, 2021. "Macroeconomic policies and the pandemic-driven recession," International Review of Economics & Finance, Elsevier, vol. 72(C), pages 438-465.
  • Handle: RePEc:eee:reveco:v:72:y:2021:i:c:p:438-465
    DOI: 10.1016/j.iref.2020.12.010
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    Cited by:

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    2. Yugang He & Yinhui Wang, 2022. "Macroeconomic Effects of COVID-19 Pandemic: Fresh Evidence from Korea," Sustainability, MDPI, vol. 14(9), pages 1-14, April.
    3. Nguyen Ngoc Thach, 2023. "Applying Monte Carlo Simulations to a Small Data Analysis of a Case of Economic Growth in COVID-19 Times," SAGE Open, , vol. 13(2), pages 21582440231, June.
    4. Beniamino Callegari & Christophe Feder, 2022. "The long-term economic effects of pandemics: toward an evolutionary approach [Epidemics and trust: the case of the Spanish flu]," Industrial and Corporate Change, Oxford University Press and the Associazione ICC, vol. 31(3), pages 715-735.
    5. Bazán-Palomino, Walter & Winkelried, Diego, 2021. "FX markets’ reactions to COVID-19: Are they different?," International Economics, Elsevier, vol. 167(C), pages 50-58.
    6. Liu, Qingfu & Shi, Chen & Tse, Yiuman & Zhang, Linlin, 2023. "The impact of public health emergencies on small and medium-sized enterprises: Evidence from China," Global Finance Journal, Elsevier, vol. 58(C).
    7. Acurio Vásconez, Verónica & Damette, Olivier & Shanafelt, David W., 2023. "Macroepidemics and unconventional monetary policy," Economic Modelling, Elsevier, vol. 126(C).
    8. Díaz, Fernando & Henríquez, Pablo A. & Winkelried, Diego, 2022. "Stock market volatility and the COVID-19 reproductive number," Research in International Business and Finance, Elsevier, vol. 59(C).
    9. Hanns de la Fuente-Mella & Rolando Rubilar & Karime Chahuán-Jiménez & Víctor Leiva, 2021. "Modeling COVID-19 Cases Statistically and Evaluating Their Effect on the Economy of Countries," Mathematics, MDPI, vol. 9(13), pages 1-13, July.

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    More about this item

    Keywords

    Pandemic; Taxation; Public spending; Monetary policy; DSGE model; Zero lower bound; Quantitative easing;
    All these keywords.

    JEL classification:

    • E59 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Other
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H00 - Public Economics - - General - - - General
    • I10 - Health, Education, and Welfare - - Health - - - General

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