Fiscal policy vs monetary policy
Guerrieri and al. in this paper are trying to answer two questions:
- Can a shock to supply, such as those experienced during a pandemic, lead to deficient demand?
- What are the combination of policy tools, monetary and fiscal, that best address this question?
They find that demand may indeed overreact to the supply shock and lead to a demand-deficient recession. Two conditions can give rise to such an effect, namely, low substitutability across sectors and incomplete markets, with liquidity constrained consumers. In that case various forms of fiscal policy, per dollar spent, may be less effective in this model. Monetary policy, as long as it is unimpeded by the zero lower bound, can have magnified effects, by preventing firm exits.
Despite this, the optimal policy to face a pandemic in this model combines as loosening of monetary policy as well as abundant social insurance.
Macroeconomic Implications of COVID-19: Can Negative Supply Shocks Cause Demand Shortages?
Authors: Veronica Guerrieri, Guido Lorenzoni, Ludwig Straub, Iván Werning
From: University of Chicago, Northwestern University, Harvard University, MIT
The effectiveness of different fiscal policies
Miguel Faria e Castro uses a nonlinear DSGE model, where the pandemic is modeled as a negative shock to the utility of consumption, to analyze the effectiveness of different fiscal policies in mitigating the economic impact of the coronavirus outbreak. He finds that:
- Liquidity assistance to firms has the longest-lasting effects and can be very effective in terms of stabilizing employment in the medium-run;
- Unemployment Insurance benefits are the most effective tool to stabilize income for borrowers, who are the hardest hit;
- Income tax cuts and unconditional transfers are also effective, but generate lower multipliers as they are less well targeted to agents with lower income;
- There are implementation lags that can be made worse by attempts to better target policies. Better targeted policies may additionally entail extra costs associated with bureaucracy. It may sometimes be better to undertake a slightly worse policy whose implementation requires less information and time, i.e. unconditional transfers vs. expansion of unemployment insurance eligibility.
Fiscal Policy during a Pandemic
Author: Miguel Faria e Castro
From: Federal Reserve Bank of St. Louis
