Economics and the Coronavirus

Several friends and family have asked me to explain, as a professor, some of the key things going on these days. First, the economic effects of the coronavirus and how to think about them. Second, what are the policies governments are trying to employ to help and why.

I made these notes and videos to help explain and provide insights. I intentionally avoid any politics and focus on just the economics.

I added some FAQ and answers below and some links to FED facilities that they announce.

Here's a video on a first-pass understanding of the monetary/financial side of the impact of the coronavirus and the US Fed's policy efforts to help.  Below the video, I include some other materials from my class to provide background.

I consider these essential to watch first. They are from my normal course. If I have time, I'll make a single, more focused background video.

 

Here's the Video: The Coronavirus and Policy - Part 1 Money

Recommended for a slightly deeper understanding

"FAQ": Some Questions and Answers

Q1: "How do we dig ourselves out of inflation paired with unemployment when the pandemic is over? I’m assuming that not all companies are going to rehire 100% of their employees at once. Also, the price increase caused by inflation will further deepen the economic crisis…many people being out of work not being able to afford high prices."

Answer 1: First, “I’m assuming that not all companies are going to rehire 100% of their employees at once”. Very true. The degree to which this happens also depends on how short-lived the economic shutdown is. If it’s a short shutdown, then not too many businesses will go permanently out of business and a bigger percent will re-hire. The longer the shutdown, the more businesses disappear permanently and hence the fewer people get rehired initially. There’s no answer for how long is “short” and exactly how many will go out of business, etc.

Answer 2: I’ll address the inflation issue below. But, the whole point is that the Fed will likely be willing to accept some higher inflation in exchange for some extra boost to growth when we the economy starts moving again.  That’ll be especially true if the shutdown is long, many businesses permanently fail, and hence more stimulus is needed.

Answer 3:  Yes, inflation can make the real cost of the crisis harder for some, but most unemployment and other benefits are “indexed” to inflation meaning they rise some with inflation. Also, we’re likely talking a couple of extra points of inflation in the USA. Maybe, for example (and a purely hypothetical example), if inflation should normally be 2% maybe the FED lets it rise to 3% or even 4%.  In some other countries, they may have to worry about, say, 10% inflation and we that will be hard but there’s no reason to expect that in the USA.  It’s also tied to your other question, Q2,... next…

 

Q2: "Can the Feds retract the money printed after the crisis is over?"

 

Answer 1: Yes. The problem is that they have to do this super carefully.  In recent years it’s been called “unwinding” when used to discuss the Fed “unwinding” the extra expansionary policy used during the Financial Crisis of 2007/08.  If you wanted the videos about the effects in the short and long run, it all also works in reverse. In the videos I show the case of an increase in the money supply increasing real GDP in the short run but only increasing the price level (“inflation”) in the long run.  So, if the FED lowers the money supply (technically it will slow its growth rate), then that will slow real GDP first, then fight inflation. So they can really only “unwind” once we have real growth again. Just to show how long this can take and how hard it is, they were just trying to seriously unwind their 2007/2008 stimulus in 2017/2018.  Markets got super nervous that they’d slow the hot stock market and slow the economy, politicians yelled at the FED, and so on.  I certainly wouldn’t want to be the FED chair 2 years from now as they try to unwind all of this.

Answer 2: First, they’ll stop the extreme lending, special lending facilities and all the extra measures. Then, they’ll slow the rate at which they pump new money into the economy.  I am guessing that they’ll start to do that this in late Summer or early Fall when things look like they’ll be on track to grow organically again.  They won’t dare to fully unwind for another few years for fear of causing a recession.

Answer 3: If, however, inflation spikes at some point (in a few years…not this year!), then they may act more quickly to unwind.

Answer 4: The general rule is that the time from “short run” to a “longer-run” can be many many months or even a couple of years.  So, the bad effects certainly won’t hit us in the coming 6-12 months.

New US Federal Reserve Facilities:

Ongoing List of New York Fed Actions Related to COVID-19 (note: this is just the NY branch of the Fed. That being said it's usually the most important for the banking system nationwide since it sits in NYC with the headquarters of most banks and fianancial centers)

Announced 6 April 2020: Commercial Paper Funding Facility (CPFF).

  • "The CPFF will begin funding purchases of commercial paper on April 14, 2020."

  • "The CPFF provides a liquidity backstop to U.S. issuers of commercial paper"

  • "Commercial paper markets directly finance a wide range of economic activity, supplying credit and funding for auto loans and mortgages as well as liquidity to meet the operational needs of a range of businesses and municipalities."

  • Their FAQ site for the CPFF: FAQs

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