The Macroeconomics of Epidemics: there is an inevitable trade-off between the severity of the short-run recession caused by the epidemic and the health consequences of that epidemic

The Macroeconomics of Epidemics. Martin S. Eichenbaum, Sergio Rebeloy, Mathias Trabandtz. March 20, 2020. https://fb8280a8-a-62cb3a1a-s-sites.googlegroups.com/site/mathiastrabandt/home/downloads/EichenbaumRebeloTrabandt_EpidemicsMacro.pdf

Abstract: We extend the canonical epidemiology model to study the interaction between economic decisions and epidemics. Our model implies that people ís decision to cut back on consumption and work reduces the severity of the epidemic, as measured by total deaths. These decisions exacerbate the size of the recession caused by the epidemic. The competitive equilibrium is not socially optimal because infected people do not fully internalize the effect of their economic decisions on the spread of the virus. In our benchmark scenario, the optimal containment policy increases the severity of the recession but saves roughly 0.6 million lives in the U.S.

JEL Classiffication: E1, I1, H0
Keywords: Epidemic, COVID-19, recessions, containment policies

6 Conclusion

We extend the canonical epidemiology model to study the interaction between economic decisions and epidemics. In our model, the epidemic generates both supply and demand effects on economic activity. These effects work in tandem to generate a large, persistent recession.

We abstract from many important real-world complications to highlight the basic economic forces at work during an epidemic. The central message of our analysis should be robust to allowing for those complications: there is an inevitable trade-off between the severity of the short-run recession caused by the epidemic and the health consequences of that epidemic. Dealing with this trade-off is a key challenge confronting policy makers.

Finally, we note that our model abstracts from various forces that might affect the long-run performance of the economy. These forces include bankruptcy costs, hysteresis effects from unemployment, and the destruction of supply-side chains. It is important to embody these forces in macroeconomic models of epidemics and study their positive and normative implications.