Rebound or Permanent Slump? Possible Impacts of US COVID-19 Fiscal Policies

INSIGHTS FROM

Daniel Murphy

WRITTEN BY: Salem Zelalem

Newswise — One great paradox of the current moment is that while COVID-19 and accompanying lockdowns have made the future far more uncertain than it had appeared just a few months prior, accurate predictions have only grown in demand. In particular, the long-term effect of recent American fiscal policy is a question with a $2 trillion price tag. Darden Professor Daniel Murphy and his co-authors, Alan Auerbach and Yuriy Gorodnichenko, tackle this question with an economic model that sheds light on how different government tactics will shape the country’s overall economic state after social distancing restrictions have been lifted.

Murphy and his co-authors point to the current issue in the economy as one of too much slack. This refers to the people, machinery and any other capital that would normally contribute to production but are currently constrained due to the pandemic. This includes, for example, all of the workers furloughed from retail jobs and any quiet conveyor belts at meat packing plants closed due to virus outbreaks. Fiscal policy — government spending and tax policy — is a potentially powerful tool to combat economic downturns. Its efficacy, however, relies on the strength of multiplier effects; in typical recessionary periods, government spending contributes to individual incomes, which in turn incentivizes more spending, with the result that each dollar in aid ultimately multiplies in impact to GDP beyond that of its face value.

While multipliers usually help fiscal policy to be more simulative in a recession, this might not be the case during the current pandemic. Instead of looking to more recent economic downturns as points of comparison, a more accurate historical precedent would be World War II. According to research from economist Gillian Brunet, fiscal multipliers during this period were smaller due to government-imposed restrictions that limited the ways in which households spent income.

This new research by Murphy and his co-authors is pivotal in that by modeling economic slack, they map the alternate paths that the economy may take in the upcoming months. In some cases, the multiplier could become small enough to cause a permanent economic slump. However, they also note fiscal policies that may actually increase the multiplier enough that GDP may become even stronger than it would have been without these global restrictions.

PERMANENT SLUMP?

Two scenarios could be powerful enough to cause a permanent slump in the economy. The first case is if wealthy individuals decrease their spending, which will have a negative multiplier effect on the economy. Large declines in spending will adversely impact businesses, resulting in declining incomes for many. As incomes decrease, people spend even less, which intensifies the issue.

A second potential permanent slump would arise if COVID-19 causes an increase in inequality (defined here as a ratio of the income share of the rich to the income share of the poor). If the opposite were to happen and inequality were to fall, low-income households would have larger income shares and be able to spend more, increasing the overall GDP. But if inequality rises, then people will continue to be unable to support other industries in decline. There are indications that COVID-19 is already causing an increase in inequality, as have past pandemics. Unless government intervention steps in soon to mediate this potential rise in inequality, this research indicates that there will be severe consequences on the country’s overall economic well-being.

SHUTDOWN VS. LOSS IN PROFIT

Many firms have already been forced to permanently leave the market due to the lockdown restrictions. While some restaurants were able to pivot to curbside pickup and creative solutions, other businesses do not have socially distant alternatives as readily available. If a firm is not forced to shut down permanently due to restrictions, then its decline in output is proportional to the share of products that have been restricted. Therefore, restrictions have a relatively limited effect, and do not multiply further into the economy. However, if a firm does close down, its complete lack of production has a much higher multiplier effect on GDP. As a result, Murphy and his co-authors find that the shutdown of firms is particularly dangerous to long-term economic growth, far greater than that of businesses that experience a loss in profit but ultimately manage to adapt.

EXPANDING GDP THROUGH HOUSEHOLD AID

Perhaps the most surprising finding: If low-income households receive a net transfer of aid from the government, and if most firms are able to continue producing in the future, COVID-19 restrictions can actually increase future output and inflation. This is due to consumption smoothing: the concept that, when determining how much to save or spend, people generally wish to keep their consumption levels relatively stable. Since the pandemic has created limits on current consumption, low-income households will choose to save a higher portion of aid and spend more in the future, when there are a wider variety of goods available for purchase. This pattern was evidenced following World War II; when there were restrictions on household spending, inflation increased, and after the war, households spent more.

When low-income households have a smaller proportion of the total income share, which is the measurement for high inequality, then aid transfers have less effect. This is because less circulates back into incomes for these households, further limiting the amount they can spend.

Ultimately, decreasing inequality is imperative for the efficacy of fiscal multipliers. Under the Coronavirus Aid, Relief and Economic Security Act, Americans are granted an extra $600 per week in unemployment payments, amongst other benefits. Auerbach, Gorodnichenko and Murphy’s research indicates that efforts in this vein have many potential benefits for GDP growth in the future. 

If the government was willing to give enough aid to low-income households, it could potentially offset all of the secondary economic effects of COVID-19 restrictions. Government transfers are beneficial because they stimulate output in two ways. First, they allow people to spend more money at existing firms. Secondly, this increase in spending may actually induce new firms to enter the market. These additional firms would in turn cause more private sector spending, as people begin to buy those new products. Therefore, government aid will not only result in a higher GDP due to consumption smoothing, but also due to greater output effects after stimulated firm entry.

TARGETING AT-RISK FIRMS

While the data makes clear that transfers to low-income households can have positive impact, another option to stimulate the economy is to provide government transfers to firms. This is beneficial if there are high fixed operating costs, as government aid can keep these firms from shutting down (which, as explained earlier, would be very costly). However, any money given to firms amounts to aid diverted away from low-income households. For this reason, it is best if firms that receive aid are those that would otherwise have been in danger of exiting the market due to COVID-19 restrictions. Data have already shown that this is not always the case in practice, as many large corporations have been asked to return their PPP loans. Instead, resources could be funneled to smaller companies in greater danger of insolvency.

LOOKING FORWARD

Recent data from economist Raj Chetty indicates that, as high-income households continue to decrease their spending even after many states have lifted their restrictions, this negative multiplier effect is already widening inequality. High-income jobs are often better equipped to shift to a remote environment, offering a buffer from the effects of COVID-19 restrictions that is not available for low-income households. “The rich cut back; the poor end up bearing the consequences,” Chetty remarked, indicating how the wealthy’s attempts to limit exposure to the virus leads to decreasing their spending, which has resulted in a disproportionate low-income unemployment. It is becoming more apparent that simply reopening the economy is not enough: Government aid is essential to combating the current recession.

Fiscal policies have a great capacity for enacting change — if they are effectively chosen. So far, the United States’ pandemic response has been a combination of aid to households and firms. Some may argue that this process has been inefficient or costly. However, Murphy and his co-authors’ paper gives credence to a mixed-methods approach. With so much uncertainty, and given the government’s inability to know to what extent high fixed operating costs are affecting firms or households, utilizing both channels — households and firms — allows for a wider base of support. As COVID-19 cases continue to rise across the country, this new research offers insights into which fiscal policies may bolster the economy, as well as those that have potential for long-term ramifications.

Daniel Murphy co-authored “Fiscal Policy and COVID-19 Restrictions in a Demand-Determined Economy” with Alan J. Auerback and Yuriy Gorodnichenko, both of the University of California, Berkeley.

This article was developed with the support of Darden’s Institute for Business in Society, at which Salem Zelalem is a research assistant.




Filters close

Showing results

110 of 4573
Released: 15-Jan-2021 5:40 PM EST
Research Links Social Isolation to COVID-19 Protocol Resistance
Humboldt State University

As health officials continue to implore the public to wear masks and practice social distancing, recent research by Humboldt State University Psychology Professor Amber Gaffney provides key insights into connections between social isolation, conspiratorial thinking, and resistance to COVID-19 protocols.

Newswise: Rapid blood test identifies COVID-19 patients at high risk of severe disease
Released: 15-Jan-2021 5:35 PM EST
Rapid blood test identifies COVID-19 patients at high risk of severe disease
Washington University in St. Louis

Scientists at Washington University School of Medicine in St. Louis have shown that a relatively simple and rapid blood test can predict which patients with COVID-19 are at highest risk of severe complications or death. The blood test measures levels of mitochondrial DNA, which normally resides inside the energy factories of cells. Mitochondrial DNA spilling out of cells and into the bloodstream is a sign that a particular type of violent cell death is taking place in the body.

Released: 15-Jan-2021 2:55 PM EST
COVID-19 deaths really are different. But best practices for ICU care should still apply, studies suggest.
Michigan Medicine - University of Michigan

COVID-19 deaths are indeed different from other lung failure deaths, according to two recent studies, with 56% of COVID-19 patients dying primarily from the lung damage caused by the virus, compared with 22% of those whose lungs fail due to other causes. But, the researchers conclude, the kind of care needed to help sustain people through the worst cases of all forms of lung failure is highly similar, and just needs to be fine-tuned.

Released: 15-Jan-2021 2:50 PM EST
45% of adults over 65 lack online medical accounts that could help them sign up for COVID-19 vaccinations
Michigan Medicine - University of Michigan

As the vaccination of older adults against COVID-19 begins across the country, new poll data suggests that many of them don’t yet have access to the “patient portal” online systems that could make it much easier for them to schedule a vaccination appointment. In all, 45% of adults aged 65 to 80 had not set up an account with their health provider’s portal system.

Released: 15-Jan-2021 1:30 PM EST
New England Journal of Medicine publishes COVID-19 treatment trial results
University of Texas at San Antonio

A clinical trial involving COVID-19 patients hospitalized at UT Health San Antonio and University Health, among roughly 100 sites globally, found that a combination of the drugs baricitinib and remdesivir reduced time to recovery, according to results published Dec. 11 in the New England Journal of Medicine.

Released: 15-Jan-2021 12:40 PM EST
DNA test can quickly identify pneumonia in patients with severe COVID-19, aiding faster treatment
University of Cambridge

Researchers have developed a DNA test to quickly identify secondary infections in COVID-19 patients, who have double the risk of developing pneumonia while on ventilation than non-COVID-19 patients.

Released: 15-Jan-2021 12:30 PM EST
Fight CRC To Present Research Findings on The Impact of COVID-19 on the Colorectal Cancer Community at 2021 GI ASCO
Fight Colorectal Cancer

Fight Colorectal Cancer presents abstract at Gastrointestinal Cancer Symposium highlighting the need to address the barriers and opportunities for care within the colorectal cancer community during the COVID-19 pandemic

Released: 15-Jan-2021 12:25 PM EST
Technion to Award Honorary Doctorate to Pfizer CEO Dr. Albert Bourla
American Technion Society

Israel's Technion will award an honorary doctorate to Pfizer CEO and Chairman Dr. Albert Bourla, for leading the development of the novel vaccine against SARS-CoV-2, the virus that causes COVID-19. The honorary doctorate will be conferred at the Technion Board of Governors meeting in November 2021.

Released: 15-Jan-2021 11:30 AM EST
UW researchers develop tool to equitably distribute limited vaccines
University of Wisconsin-Madison

Researchers at the University of Wisconsin School of Medicine and Public Health and UW Health have developed a tool that incorporates a person’s age and socioeconomic status to prioritize vaccine distribution among people who otherwise share similar risks due to their jobs.


Showing results

110 of 4573

close
1.13767