the economic ripple effects of covid-19 - world...

The Economic Ripple Effects of COVID-19

Francisco J. Buera1 Roberto N. Fattal-Jaef2

Hugo Hopenhayn 4 P. Andrés Neumeyer 3 Yongseok Shin 1

1Washington University in St. Louis

2World Bank 3Universidad Torcuato Di Tella 4UCLA

Universidad Torcuato Di TellaJune 3, 2020

Motivation

• COVID+non-pharmaceutical interventions (NPIs):

. largest (transitory ?) aggregate shock since...

. more permanent reshuffling of what/how we consume

• This paper:

. Ripple effects of a LARGE transitory shock, e.g., Lockdown?

. Ripple effects of a pure reallocation shock?

. How effects depend on policies/institutions?

Motivation: How Bad, For How Long?

Motivation: Neoclassical Dynamics of Lockdown

Related Literature

• See NBER Working Papers 26867-27281

This Paper

• Heterogeneous Agents model. occupational choices. stochastic ability

zt =

{zt−1 with prob. ψt

z ∼ 1− z−η otherwise

. credit friction: collateral constraints, kt ≤ λat

. labor friction: matching friction w/ rest unemployment

• Deterministic dynamics following unanticipated shocks:. Lock-down: fraction φ of all firms becomes Non-Essential (shut-down).. Reallocation shock: 10% of individuals redraw their productivity,

0.87 = ψ1 < ψ = 0.97

• Buera, Fattal-Jaef & Shin (2015)+ (simple version of) Alvarez & Shimer (2011)

Roadmap

• Analyze macro and micro implicatons of:

1. one-period lockdown shock, three cases:

1.1 non-essential firms have no income, liable for rental/debt payments (baseline)

1.2 also liable for wage payments, i.e., no wage subsidies/furloughs

1.3 small open economy with tighter credit constraints...

2. Pure reallocation shock...

Agent’s Optimization Problem: Essential

vt (z , a) = maxa′,oc

{[ct ]

1−σ

1− σ+ βEvt+1

[z ′, a′

]}ct + at+1 = max {wt ,πt (z , at ; rt ,wt)}+ (1+ rt) at − Tt

whereπt (z , a; r ,w) = max

k,lzkαl θ − (rt + δ) k − wt l

subject to k ≤ λa

• Full replacement unemployment insurance: wt

• Lump-sum taxes with budget balance, Tt = wtUt

Agent’s Optimization Problems: Non-Essential

• Businesses

vNE1 (z , a) = maxa′

{[ct ]

1−σ

1− σ+ βEv2

[z ′, a′

]}c1 + a2 = − (r + δ) k1− + (1+ r1) a1 − T1

• Workers

vW1 (z , a) = maxa′

{[ct ]

1−σ

1− σ+ βEv2

[z ′, a′

]}c1 + a2 = w1 + (1+ r1) a1 − T1

• Non-essential entrepreneurs only pay rental cost, − (r + δ) k1−. employment at will (US) or generous government wage subsidies (Europe)

• non-essential become essential for t ≥ 2

Labor Market Friction

• Mt unemployed workers matched to the hiring market

Mt = γ (Ut + JDt)

• Evolution of Unemployment

Ut+1 = Ut + JDt −Mt

• Job Destruction

JDt =∫

[max {l−1 − lt (a, z) , 0}][dGE

t + dGNEt

]+ exiting entrep.

• Walrasian Hiring Market Clearing∫lt (a,z)>0

[1+ lt (a, z)][dGE

t + dGNEt

]︸︷︷︸

labor demand

= 1− Ut+1︸︷︷︸labor supply

Labor Market Friction with Rest Unemployment

• non-essential workers are not reallocated in the first period

• but can be rehired frictionlessly by their previous employers in the secondperiod

. only by surviving firms

. if their net-worth constraint does not bind

Labor Market Friction with Rest Unemployment

• Mt unemployed workers matched to the hiring market

M1 = γ (U1 + JD1 − R1)

M2 = γ (U2 + JD2 − RH2)

where

R1 = job destruction by surviving non-essential firms in t = 1

andRH2 = ψ

∫l0>0

max {min {l2 (a, z) , l0} − l1, 0} dGNE2

. i.e., job destruction by non-essential can be re-hired the following period

• Evolution of Unemployment

U2 = U1 + JD1 −M1

U3 = U2 + JD2 −M2 − RH2

Calibration Strategy

• Parameter values set to match

. distribution and dynamics of U.S. establishments

. unemployment rate in U.S. (γ)

. external finance to fixed capital in non-corporate sector in U.S. (λ)

I also calibration to external finance in developing countries

Roadmap







The Lock-Down Shock

• Start from stationary allocation

• Unexpected shock: fraction φ of businesses considered Non-Essential

. magnitude and persistence of φ still open question

. assume φ = 0.3 , 1-period shock→emphasize model’s propagation

. shock realized after occupation and factor demand decisions, but beforeproduction

• two assumptions about labor costs in the first period:

. are not paid by the firm, e.g., wage subsidies (Europe), furlough (US)

. firm must paid wage bill

Propagation Forces

1. Burst of job destruction+matching friction→ rise in Unemployment

2. Imperfect insurance→ heterogeneous effect on net-worth

3. Financial Frictions→ TFP , investment, rehiring dynamics

Roadmap







Lockdown: Aggregate Variables I

Lockdown: Aggregate Variables II

Micro Implications I: Employment by Age

Young: less than 5 year old

Micro Implications II: Consumption

Lockdown: Role of Rest Unemployment

Roadmap







No Wage Subsidies: Aggregate Variables I

No Wage Subsidies: Aggregate Variables II

Micro Implications: Employment by Age

Young: less than 5 year old

Roadmap







Small Open Economy: Aggregate Variables I

Roadmap







Pure Reallocation Shock

• Start from stationary allocation

• Unexpected shock: 10% of individuals redraw their productivity,0.87 = ψ1 < ψ = 0.97

. ∼ 10% of old businesses need to be replace by new ones

. in a neoclassical world there are no aggregate consequences

. process slow by financial and labor frictions

• It captures more permanent reshuffling of what/how we consume/produce

. online person academic/business conference

. changes in type of recreation and vacations

Pure Reallocation Shock: Aggregate Variables I

franciscobuera

Line

Pure Reallocation Shock: Aggregate Variables II

Summary of Results

1. Fast aggregate recovery (with wage support/flexible employment & rest)

2. but large, persistence effects for young firms

3. fall of interest rate (∆ aggregate demand<∆ aggregate supply)

4. large ripple effect without wage support/inflexible employment

5. capital outflows from financially underdeveloped, small open economies

Work in Progress, Further Extensions

• Distribution of welfare costs. Who gain from wage subsidies, milder ripple effects?

• Lockdown of different duration. Are cost convex in the length?

• Capital irreversibility, Kt+1 ≥ (1− δ)Kt

. Extension relevant for the case without wage subsidy, SOE with tighter creditconstraint

. Initial drop in the price of capital, further tighten constraints, e.g., Kiyotaki &Moore (1997)

• Debt financed support policies. Further depress investment. Ameliorate initial fall in consumption of constrained agents

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