Winner of the New Statesman SPERI Prize in Political Economy 2016


Monday, 23 March 2020

The economic (and political) effects of this coronavirus pandemic


This is an update of an earlier post where I described the results of a study I did with others on a flu pandemic. (It also appeared in a VoxEU ebook.) I have had a lot of enquiries from journalists in Europe about this blog and the paper, and of course what everyone wants to know is how similar is our modelling to the impact of this coronavirus. The features of this pandemic are now clearer than when I wrote the post, so I can say a few things on this issue.

Our study looked at two cases: a base case and a severe case. The key parameters were the attack rate (how many get the virus) and the fatality rate (how many who get the virus eventually die). The base case is far milder than this coronavirus, so I’m going to focus on the severe scenario we modelled. That had an attack rate of 50%, and a fatality rate of 2.5%.

How does this coronavirus compare to that? The attack rate is almost certainly higher: we are only beginning to know the number of people who get the virus without even knowing it. The fatality rate of this coronavirus is unknown, partly because of the uncertainty about the attack rate. At first it was thought to be above the 2.5% number in our severe scenario, but it now looks like it is lower. However this number is not critical for the direct economic impact of coronavirus.

The reason is obvious once you think about it. The fatality rate for coronavirus is mainly among those who are retired, so there will be little impact on the size of the long term workforce. However there is a huge indirect effect of a high mortality rate, and that is on how the government reacts to the pandemic. I will talk about that below.

So the severe case seems, so far, a useful guide. In our paper we also looked at the impact of a large fall in ‘social consumption’ (pubs and restaurants, travel etc). We looked at a pandemic with or without this, partly because our base case was mild, and partly because some previous studies had not looked at this. However it is already clear that we were absolutely right to look at this issue. Airline industries around the world are mothballing most of their planes, restaurant bookings were way down before they were ordered to close, and so on.

One final point, that I will also discuss below, is that we assumed the pandemic was just a three month affair. If we look at our severe pandemic case including falling social consumption, we had GDP in the pandemic quarter falling by 30%. There was a similar fall in consumption. However, because our severe pandemic lasted for just one quarter, GDP for the year as a whole fell by only 6%. So how good a guide - in rough orders of magnitude - are those numbers to this coronavirus pandemic?

Let us look at the first quarter impact first, because that we know most about. Pretty much all Western countries have a suppression regime in place, which will probably last around three months while the virus numbers are brought right down. This reduces GDP from both the supply and demand side, and this combination makes it tricky to model with any degree of accuracy. The reason the fall in demand and supply don’t completely complement each other is that the fall in demand is going to be concentrated in sectors, while the supply side impact is more widespread.

Our study suggested the main supply side impact comes from school closures. On the reasonable assumption that these last until the summer holidays, that means a large section of the workforce will have to stay at home rather than work. (It will be interesting how the ONS measure output from working at home!) In contrast those who get sick will be off work for only two weeks. Furthermore, and unlike our exercise, workers will be reluctant to use grandparents if they get a choice.

On the demand side the drop in social consumption that we assumed would happen through individual choice will now be made by government advice/instruction. You can do your own calculation by looking at a breakdown of consumption. There is a limit to how far GDP can fall because we will not eat less, and we will not spend less on housing or heating. Expenditure on clothing and particularly durables may be delayed to some extent, as people avoid personal contact, but online purchases should continue.

Given all this, our estimate of a fall in GDP in the first quarter of the outbreak of -30%, although huge, does not look obviously wrong and may well be an underestimate. But of course this is not a precise figure at all, and it will vary from country to country depending on the strength of social distancing controls, the degree of business and worker support from governments and whether governments can relax social distancing before 3 months are up. The GDP fall could easily be 20% or 40%. Because the crisis began in most Western countries at the end of the first quarter, the Q1 GDP fall will be a lot less than this, and the Q2 fall relative to Q1 will be slightly less. 

Where our study is less helpful is in thinking about what happens after the strict control period comes to an end because new cases come right down. We assumed there would be no attempt at suppression beyond school closures (because our main case was much milder), so our pandemic ended after three months. This coronavirus pandemic will not be a one quarter affair, because governments quite rightly have not been prepared to see a short sharp peak where their health services will be overwhelmed. 

Once the number of cases are brought right down, it is likely governments will do what China is currently doing, and move to a strict contain regime. This involves a very stringent regime to test those who might still get the virus and the isolation of all known contacts, combined with some continuation of social distancing controls. China even has an app that helps do the tracing. I think this will inevitably be how other countries deal with the virus once numbers are down. Some will do it well, and others may not, leading to controls being reintroduced.

Containment is, of course, what all Western countries tried to do at first, but in nearly every case they moved too slowly. (The UK even tried the herd immunity route, despite what ministers might say, and seem not to have done the basic sums of what that meant for the NHS and deaths.) This general initial failure was not inevitable: a few countries like Singapore have been much more successful. In short, nearly all Western governments underestimated how quickly the virus would spread. But it is easier to control the virus by relaxing controls than creating such controls from scratch, and hopefully lessons have been learnt. In addition, governments will have had time to ramp up testing capacity, and think about better tracing.

The key issue for the economy once numbers come down is how many controls can be reduced or eliminated while keeping a lid on new case numbers. Once again on the supply side whether schools reopen is key, and on the demand side it is what parts of social consumption can be made safer. Because some relaxation will almost certainly be possible, then GDP growth will partially bounce back, but how much they will bounce back is very unclear at present. Here our study, which had GDP being above the no-pandemic case in the second quarter, does not apply to the pandemic we are now in. As a result, the first year GDP impact of -6% in our study is much too small. It is impossible to predict what the full year impact will be until we know what controls are essential and what controls can be relaxed while maintaining an effective test/trace/isolate regime. We will get some idea from China.

I want to add a little, much more speculatively, on political consequences. There has been some talk about this pandemic provoking a scaling back of globalisation. You can see that happening if talk about this being a Chinese virus brought in by foreigners is given air time. But it is equally possible that the opposite will happen as a result of the virus.

As we relax controls, governments will want to know what countries it can open up travel to. That will depend on how effective their test/trace/isolate regime is. As we have already seen with Macron phoning Johnson to urge stronger controls, international pressure of this kind will happen. As this goes on, there will therefore be a huge incentive for countries to copy successful measures. At the start of this pandemic we saw a complete lack of global coordination, despite WHO’s best efforts. Subsequently we should see much more.





Monday, 16 March 2020

Coronavirus and the consequences of a compliant media


This hasn’t been the new government’s first nationwide crisis. That was widespread flooding hitting many regions of the UK. As I explained here, that was partly a disaster created by the Conservative party (with a little help from their coalition partners). Journalists had their chance to make a story out of this by using the hook of Johnson’s non-appearance at any of the flooded towns, but it didn’t happen, just it didn’t happen on all the previous occasions we have had widespread flooding. Which is why spending on flood defences continues to be inadequate.

Lack of criticism encourages a certain laziness, but also gives politicians the courage to do things that those in democracies with more accountability would not do. I think we can see both in the coronavirus crisis.

In the initial phase of the UK pandemic, where cases were mainly coming via contact from abroad, the NHS were trying to prevent infections by tracing and getting those who had contact with the virus to isolate themselves. For that phase to have any chance of working, the Prime Minister needed to impress upon the country the importance of voluntary social distancing, so that cases the health service missed did not pass the virus on. Instead the Prime Minister continued to shake hands as if nothing had happened. He even suggested the media was overreacting to the virus.

That was a very personal example of laziness. But more generally the government needed to get across the seriousness of the situation without creating widespread panic. The best way to do that is to create social solidarity and trust in government. You create trust in government by openness. It is not good enough to say you are following the science and not be honest about the science and the alternatives available, so everyone can understand why you are taking a particular course. .

The government started from a difficult position because its actions elsewhere had created a very divided society. There would always be those that questioned what they were doing. But if the government really was following the science, and it was obvious to anyone who investigated the literature the government released that it was following the science, then that politicising of the government’s approach would have been limited.

You can see this in the behaviour of the opposition. They initially did not question or criticise what the government was doing. In a crisis they were prepared to give the government the benefit of doubt. But if that was to last it required bringing the opposition alongside as part of a national effort, by for example including an opposition minister or the mayor of London in COBRA meetings.

None of this happened. One of the reasons it didn’t happen is that the government knew it faced a largely compliant media. On social media there were enough friendly voices to try and shut down those who “questioned the science”. Blunders came and went with no consequences, such as Hancock’s premature claim that he was working with retailers, the 111 service giving the wrong advice and with too few staff to take calls, and delay in checking at airports and getting people to quarantine themselves.

The government’s strategy, of keeping information tight and endlessly repeating that they were following the science, might have been enough if it hadn’t been for many other countries following a different path to the government once it was clear that the containment phase was not working Other countries seemed to be introducing more stringent measures to ensure social distancing than our government. A few, like Italy, were doing so because the pandemic was uncontrolled and they had no choice. But other countries, like Ireland on our doorstep, did it from choice. It seemed clear that the UK was following a different path and it wasn’t clear why. When people like the editor of the Lancet started questioning the strategy, news programmes like Channel 4 News and Newsnight began to ask questions. And those questions were not answered.

People started taking their own actions to ensure social distancing. Universities started teaching online and large events were cancelled. Then Scotland jumped ship and suspended large gatherings, and later the football league suspended matches. At that point the government, which was supposedly following the science, seemed to panic and follow Scotland’s lead. Rather than the government leading a national effort, it appeared to be playing catch up.

I think it is fair to say that the government’s communications strategy has been chaotic. You cannot communicate to people in a crisis like this with occasional press conferences and off the record briefing to the odd journalist, or with your health minister writing behind paywalls in the house newspaper. You cannot pretend that you are aiming to protect the vulnerable and elderly when you offer no guidance to those groups to limit social contacts. You cannot keep saying you are following ‘the science’ when most other countries are doing something very different, because science is international. And you cannot tell people questioning your approach to be quiet to stop panic when you brief a journalist to say
“What keeps ministers and officials awake at night is the fear that if the epidemic becomes too great they would have to make appalling decisions, such as that the NHS would stop treating people over a certain age, such as 65.”

Alot of this is laziness encouraged by the belief that most of the media will back you come what may. But I also want to talk about risk taking, and a good way of introducing this is to look at this clip from the Irish media talking about how they see the UK strategy. Please also read James Meadway’s comment, which is very pertinent to the subject of this blog. Please view and read it before continuing.

In this Irish view, and many who have tried to work out why the UK strategy seems more laid back than elsewhere, the UK idea is to generate widespread immunity before winter hits the NHS and social distancing no longer works. The idea is to flatten the curve, but not too much. It is the only explanation I can come up with for the comparative lack of action in the UK compared to elsewhere, including Ireland. So let us suppose that is the strategy.

Other countries are trying to flatten the curve by much more, and perhaps even with the aim of eventually being to make the ‘contain phase’ work. That seems to be the idea in China. I don’t want to speculate on which strategy is right or wrong, because I don’t have the skills to do so (although this is a strong critique of the UK approach). What I think is worth noting is that the UK strategy is very brave from a political point of view. In the short term it is quite likely that a lot more people will die in the UK than in other countries. And while the UK strategy may be proved right in the longer term, there will always be a risk that this will not happen.

Many politicians, subject to a reasonable and fearless degree of internal scrutiny, would reject the UK strategy as just too risky - for them. However if a politician is not subject to strong internal scrutiny, they might be tempted to take a greater risk. That may be what is happening in the UK, as it is happening with Brexit. With Brexit it is people getting poorer, but with this crisis it is people dying.

This is particularly the case when the UK more than other countries has a health service that has been stripped to the bone, working at more than full capacity at normal times. This may be the reason that the government has adopted this strategy - it is trying to avoid a larger crisis developing at the worst time for the NHS at the beginning of next year. Capacity constraints in the amount of testing it can do may have caused the government to abandon widespread testing so soon, including testing NHS staff. The government doesn’t believe it can keep enough social distancing going until this time next year, even though it would have six more months to prepare.

Here we come to the major reason why weak media scrutiny puts this country at far greater risk than elsewhere. We have had 10 years where the NHS has been starved of resources, and the media has been shamelessly repeating the government line that the NHS has been protected. Every medic knows that you cannot keep spending on the NHS constant (even in real terms) and not end up with an NHS crisis. Yet this government spin has been repeated ad nauseam. And then of course we have had Brexit which has robbed the NHS of invaluable doctors and nurses. The government took a huge risk with the NHS by implementing austerity and Brexit, and they could do so because of a largely compliant media. Now many people my age and older could end up paying the ultimate price.

Update 17/03

So yesterday, if you listen to the BBC, “the science changed”. Yet in reality a good bit of why the advice changed was obvious to many before it changed: just look at this clip from Irish TV. More detail here and here. That it took those advising the government longer than many outsiders to see what was wrong should be the subject of an inquiry once this is all over. We can only guess what happened. Plans drawn up for a more serious than normal flu pandemic became part of internal government groupthink, when in fact we should have been treating this pandemic as something we should suppress rather than control. It also seems, incredibly, that not enough time was spent telling politicians about the risks involved in following their original strategy.

Even now I worry that the government is being too 'British' about this, with lots of advice and recommendations. When is travel essential? Here and here are examples of what happens when that advice is not followed, because no sanction is attached to not following it. Three other points that are now clear. First, the government did not prepare for all this early enough, and the media should be giving them hell for this failure. (Most of the media won't, for reasons described in the post.) Second all those who said people had no right to criticise because the government was following the science now look extremely foolish, and they need to admit their mistake.

But third and most importantly, the majority of the media that gave very little time to the concerns of others need to reflect on how many lives their inaction may have cost. As James Meadway reminds us, it was Amartya Sen who suggested that a free press meant less deaths in famines, and now we can see why.    


Monday, 9 March 2020

Fiscal rules: a primer for the budget


Do you want to know why fiscal rules should never involve targets for the debt/GDP ratio, or debt interest, or any stock measure, and why public investment should not be part of a fiscal rule? Read on, but first we have to establish two key principles.

Principle 1: what are fiscal rules for?

The way some economists are tempted to think about fiscal rules is in terms of economic optimality. What is the optimum debt to GDP ratio and what is the best way to get there? This misunderstands what fiscal rules are for. If every government was benevolent (always did the right thing for society) they would follow the optimal policy without the need for fiscal rules. Governments would just consult experts and do the right thing. Why try and formulate the optimal policy into a rule?

Fiscal rules are there to restrain governments from not being benevolent. For many governments the attraction of fiscal giveaways just before an election (and letting monetary policy deal with the consequences for inflation and future generations the responsibility of servicing the extra debt) is too great. Before the GFC the OECD’s debt to GDP ratio was almost double what it was 30 years earlier. In addition right wing governments have discovered that austerity during a recession is a good way of shrinking the state while pretending to be responsible at the same time. When I talk about an irresponsible government below, austerity is the clearest example of a government behaving irresponsibly.

So fiscal rules are part of the apparatus to ensure the government does not give in to either temptation. Good fiscal rules are not overriding democracy but dealing with a negative externality of democracy that occurs because electorates can be fooled. The first best option would be to educate electorates so they could not be fooled, but in a society where the media makes that impossible fiscal rules and fiscal councils are a good second best. Fiscal rules do not override democracy because governments choose to follow them and have the option of ignoring them. No fiscal rule should ever be enshrined in a constitution.

Principle 2: rules should not ignore optimal policy

As my paper with Jonathan Portes explains, fiscal rules are a delicate balance between stopping a government being irresponsible and not stopping them behaving optimally. Too often rules seem designed mainly to constrain governments with little regard to what an optimal fiscal policy would be. Rules that force governments to enact a fiscal policy that harms the economy are bad rules, and are unlikely to be met for very long.

The clearest example of that is when fiscal rules stop a government stimulating economy when interest rates are stuck at their lower bound. Every fiscal rule before the one proposed in our paper had this fault. Every fiscal rule enacted in the UK has had this fault.

Five requirements for a good fiscal policy rule

  1. The rule must mandate fiscal stimulus in a recession where interest rates hit (or might hit) their lower bound.

  2. Debt and deficits are shock absorbers, and fiscal rules should interfere with that as little as possible while still discouraging irresponsible government behaviour. We discuss how to achieve that in detail below, but one clear implication is that fiscal rules should involve deficit targets and not debt targets [1].

  3. Public investment should not be part of any deficit target. To abandon good investment projects to reduce the deficit is a cure worse than the disease. The best way to stop white elephant investment projects is not some arbitrary limits on the share of investment to GDP, but an infrastructure commission with some power.

  4. A fiscal council with teeth is an essential complement to a fiscal rule. Such a fiscal council (which has more power than the OBR) can allow a more optimal fiscal rule.

  5. A good fiscal rule should be designed to last. It should have a structure that can deal with all eventualities. But there is every reason to revisit the deficit target every five or ten years in conjunction with the fiscal council and an open debate.

Requirements (2) and (4) interact. A fiscal rule that allows the maximum discretion for governments to allow deficits to be a shock absorber is a rolling five year target. Future targets with a fixed date become problematic as that date approaches, because any shocks just before the date require damaging short term fiscal adjustments, violating (2). But a rolling target allows the government to cheat, because the target never arrives. A fiscal council that can call out such cheating (and which carries political clout) allows a more optimal policy.

How well have the Conservatives done since 2010?

The obvious point is that in 2010 the Conservatives became the most irresponsible government since the General Theory was written in 1936 by violating requirement (1) and giving us austerity. Ironically by adopting a five year rolling target for the current balance (the deficit less investment) the rule met requirements (2) and (3). They created the UK’s fiscal council, the OBR, but failed to give it a strong enough mandate to effectively call out cheating. Rupert Harrison brought with him the expertise of the IFS in formulating the rule, but perhaps because the IFS did not do macro or perhaps for other reasons requirement (1) was ignored, at the very point interest rates hit their lower bound.

That was the high point for fiscal rules under a Conservative Chancellor! Despite the fact that their main rule excluded public investment, the government cut it sharply anyway, which is why the recovery was delayed from 2010 to 2013. Later on the Chancellor decided to play with fiscal rules as if they were his own political plaything to embarrass the opposition with, and I have lost count of how many there have been. A lot of the blame here lies with the media. Gordon Brown was strongly attacked when he allegedly fiddled with the definition of the cycle, but he kept to his fiscal rule for 10 years and it was important at influencing policy. In contrast Osborne was allowed to change fiscal rules as he liked, with very little comeback.

Where do we now stand? We will see shortly, but I would be very surprised to see any rule that meets the first requirement. To do so would come too close to admitting austerity was a mistake. (Something in a rule that allows the automatic stabilisers to work does not meet requirement (1), because in a recession where interest rates are stuck we need a substantial fiscal stimulus.)

The fiscal rule at the time of the 2019 Tory manifesto was “to have the current budget in balance no later than the third year of the forecast period; to limit public sector net investment to 3% of GDP; and to reassess plans in the event of a pronounced rise in interest rates taking interest costs above 6% of government revenue.” This rule illustrates how far backwards we have come since Osborne’s first fiscal rule. The deficit target involves a fixed date rather than being rolling. The current balance is still the target, but there is an arbitrary limit on public investment. (Osborne went even further backwards for a time by targeting the whole deficit.)

What number should the deficit target (excluding investment) be?

Good fiscal rules should have a structure that is designed to last, and a good way of testing them is to see how they would have done over the past. Including a debt target in a fiscal rule is a sure way of making it not last: this was why Gordon Brown’s rules failed. However, as requirement (5) states, there is no reason why you shouldn’t change the deficit target within the rule every decade or so, to reflect changes to your views about long term interest rates and other factors. One possibility is to give the OBR the responsibility of reviewing the deficit target every five years, taking into account changing views about long term interest rates, trend growth rates and what the ultimate debt to GDP target should be.

This is where debt interest should come in. This issue is discussed in detail in a recent paper by the Tony Blair’s Institute, and here I will only make the key point. If you target, say, is to keep the debt to GDP ratio constant, what the primary deficit (the deficit excluding interest payments) should be depends on what interest rates on debt currently are expected to be and what the growth rate of nominal GDP is expected to be. Interest rates matter because they raise the stock of nominal debt for a given primary deficit, and the growth of GDP matters because it reduces the debt to GDP ratio.

Of course the difference between the actual deficit and the primary deficit are debt interest payments. So far governments have tended not to target the primary deficit. In that case the issue is whether current debt interest rates are different from what they are expected to be in the future. This is possible if interest rates on debt are falling and a lot of debt is long term. It is complicated, which is why a body like the OBR needs to be involved.

Why is a maxima (and perhaps minima) for debt interest payments, as proposed here for example, not a good idea for a fiscal rule? Debt interest is just the debt stock times the average interest cost of debt. As a result, it suffers from the same problems as a target for the debt stock alone. Although some positive shocks to debt are correlated with lower interest rates, not all are. And even if they are, why should the correlation be just what is required to smooth fiscal policy?

So far I have talked about long run targets for government debt to GDP rather than government net wealth. This is simply because it is a more familiar concept. In advising on what the deficit target should be, a fiscal council should look at government net worth as well as levels of debt. A government that sells off a profitable asset in order to reduce its debt is just pulling the wool over people's eyes, and schemes like PFI are in danger of falling into a similar trap. 

How should we define public investment?

Requirement (3) excludes public investment from the deficit target, because that investment benefits future generations. But some current spending has some benefits for future generations too, like education. So is the national accounts definition of pubic investment too limited for a fiscal rule? There are rumours the Chancellor is thinking along these lines.

First, it is important to clear up a common confusion. A bridge built with public money will hopefully benefit many generations to come. But a bridge requires constant servicing, and that cost is part of current spending. Does this make sense? Yes it does. You can think of that servicing cost as the price that every generation has to pay to keep the asset in place. There is no reason the current generation should be exempt from paying that. Equally a new hospital should last for many generations, but every generation needs to pay for the nurses to staff the hospital.

What about education? Education isn’t like a bridge. It is not like a one off expenditure that ends when the bridge is complete. If a government decides to reduce class sizes (say), that requires more sending now but more spending in the future as well. Like servicing a bridge, it is a constant commitment that requires constant resourcing to match it.

Public investment should be excluded from the deficit target not just because it helps future generations, but also because it is a one-off investment that will benefit future generations.

Financing a Green New Deal

This discussion is important in thinking about financing spending to combat climate change. Making energy production green is a clear example of a one-off investment to benefit future generations. For this reason some economists have understood why government debt should rise to pay for greening the economy. As I explain in the link, there is a limit to how much this should be done, because the polluter (the current generation) should pay. But as I said here, no fiscal rule should be used as a pretext to stop vital work to green the economy.

Why not run fiscal policy like monetary policy

Interest rates are decided by central banks, or committees including some outside experts as in the UK. No one is suggesting a similar committee of experts can enact budgets, but could they - as Jagjit Chadha suggests here - set the overall deficit any Chancellor has to achieve in their budget. This committee, perhaps part of an enhanced OBR, could work out what the optimal deficit path is to achieve some long term objective for the debt to GDP ratio. No need for fiscal rules.

Inflation targeting works because everyone wants low inflation, and crucially everyone should realise that how you get it is an issue that involves a great deal of expertise. You need to have a model of how the economy works. Aggregate fiscal policy is not like that. There is no analogy to low inflation. Stable debt to GDP might come close, but many would argue that after the GFC debt is too high, and others would disagree. These views are worlds apart.

The same is true about how you get to any long run target. As I suggested above, macroeconomic theory suggests you should do it slowly but does that mean 50 years or 100 years? We just do not know. As a result, I suspect that at the end of the day all the experts would be able to agree on is general virtues like fiscal smoothing. This virtue can be embodied in a good fiscal rule.

Let me put the same point in a slightly different way. You can have rules for good monetary policy, but I suspect the majority would agree that a committee of experts could do better than this rule. I’m not sure the same applies to fiscal policy if the rule is good.

There is also a political economy issue. I doubt that a committee of experts setting the deficit Chancellors had to achieve would last very long. For that reason I don’t think it would ever be established. Maybe if academics devoted as much time and energy to fiscal policy as they do to monetary policy then in twenty years maybe, but it is not a viable proposition right now.


[1] To see why, think about the impact of coronavirus on deficits and debt. Hopefully the virus will lead to a sharp but short-lived recession, which will at least reduce taxes and raise the deficit and debt. The impact on the deficit in future years will be minimal, so requiring little or no adjustment to fiscal policy in future years. This is the optimal policy response. However the debt/DGP ratio will be permanently higher because of the short term deficit, so a debt target would require a (suboptimally) rapid fiscal response. Deficit targets are better than debt targets at preserving shock absorbers.

Monday, 2 March 2020

The economic effects of a pandemic


A little over ten years ago I was approached by some health experts who wanted to look at the economic effects of a influenza pandemic. They needed someone with a macroeconomic model to look at the general equilibrium impacts. In the 1990s I had led a small team that constructed a model called COMPACT, and these health experts and I completed a paper that was subsequently published in Health Economics. We reference to other studies that had been done earlier in that paper.

The current coronavirus outbreak will have different characteristics to the pandemic we studied, and hopefully it will not become a pandemic at all. (In terms of mortality it seems to be somewhere in between the ‘base case’ and ‘severe case’ we looked at in our work.) But I think there were some general lessons from the exercise we did that will be relevant if this particular coronavirus does become a global pandemic. One proviso is that a key assumption we made about the pandemic is that it was mainly a 3 month affair, and obviously what I have to say is dependent on it being short-lived.

It is worth saying at the start that the bottom line of all this for me is that the economics are secondary to the health consequences for any pandemic that has a significant fatality rate (as coronavirus so far appears to have). The economics are important in their own right and as a warning to avoid drastic measures that do not influence the number of deaths, but beyond that there is no meaningful trade-off between preventing deaths and losing some percent of GDP for less than half the year. 

Let me start with the least important impact from an economic point of view, and that is the fall in production due to workers taking more time off sick. It is least important in part because firms have ways of compensating for this, particularly if illness is spread over the quarter. For example those who have been sick and come back to work can work overtime. This will raise costs and might lead to some temporary inflation, but the central bank should ignore this.

This ‘direct’ impact of the pandemic will reduce GDP in that quarter by a few percentage points. The precise number will depend on what proportion of the population that get sick, on what the fatality rate in the UK turns out to be, and how many people miss work in an attempt not to get the disease. The impact on GDP for the whole year following the pandemic is much less at around 1% or 2%, partly because output after the pandemic quarter is higher as firms replenish diminished stocks and meet postponed demand.

All this assumes schools do not close once the pandemic takes hold. School closures can amplify the reduction in labour supply if some workers are forced to take time off to look after children. On the basis of the assumptions we made, if schools close for around 4 weeks that can multiply the GDP impacts above by as much as a factor of 3, and if they close for a whole quarter by twice that. If that seems large, remember nationwide school closures impact everyone with children and not just those with the disease.

But even with all schools closed for 3 months and many people avoiding work when they were not sick, the largest impact we got for GDP loss over a year was less than 5%. That is a one quarter very severe recession, but there is no reason why the economy cannot bounce back to full strength once the pandemic is over. Unlike a normal recession, information on the cause of the output loss, and therefore when it should end, is clear.

All this assumes that consumers who have not yet got the disease do not alter their behaviour. For a pandemic that spreads gradually this seems unlikely. The most important lesson I learnt from doing this study is that the pandemic need not just be a supply shock. It can also be a demand shock that can hit specific sectors very hard, depending on how consumers behave. This is because a lot of our consumption nowadays can be called social, by which I mean doing things that bring you into contact with other people. Things like going to the pub, to restaurants, to football matches or travel. Other sectors that provide consumption services that involve personal contact (e.g haircuts) and can easily be postponed may also be hit.

If people start worrying about getting the disease sufficiently to cut back on this social consumption, the economic impact will be more severe than any numbers discussed so far. One reason it is severe is that it is partly a permanent loss. Maybe you will have a few more meals out once the pandemic is over to make up for what you missed when you stayed home, but there is likely to be a net fall in your consumption of meals out over the year. What I realised when I did the analysis was just how much of our consumption was social.

This is why the biggest impacts on GDP occur when we have people reducing their social consumption in an effort not to get the disease. However falls in social consumption do not scale up all scenarios by the same amount, for the simple reason that supply and demand are complimentary. If school closures and people taking more time off work increase the size of the supply shock, the demand shock has less scope to do damage. The largest fall in annual GDP in all the variants we looked at was 6%.

Could conventional monetary or fiscal policy offset the fall in social consumption? Only partially, because the drop in consumption is focused on specific sectors. What is more important, and what we didn’t explore in the exercise, is what would happen if the banks failed to provide bridging finance for the firms having to deal with a sudden fall in demand. The banks may judge that some businesses that are already indebted may not be able to cope with any additional short term loans, leading to business closures during the pandemic.

It is in this light that we should view the collapse of stock markets around the world. In macroeconomic terms this is a one-off shock, so Martin Sandbu is right that the recent stock market reaction looks overblown. But if many businesses are at financial risk from the temporary drop in social consumption, that implies a rise in the equity risk premia, which helps account for the size of the stock market collapse we have seen. (I say 'helps' deliberately, as much of the impact will be on smaller businesses that do not find their way into the main stock market indices.)  

If I was running the central bank or government, I would have already started having conversations with banks about not forcing firms into bankruptcy during any pandemic. 

But economics can also influence health outcomes, and not just in terms of NHS resources. For a minority of self employed workers there will be no sick-pay and those without a financial cushion will be put under stress. One of the concerns as far as the spread of the pandemic is concerned is that workers will not be able to afford to self-isolate if they have the disease. So if I was in government I would be thinking of setting up something like a sick-leave fund that such workers could apply to if they get coronavirus symptoms.

The government also needs to think about keeping public services and utilities running when workers in those services start falling ill. In fact there are a whole host of things the government should now be doing to prepare for a pandemic. It is at times like these that we really need governments to act fast and think ahead. Do we in the UK, and US citizens, have confidence that the government will do what is required? One lesson of coronavirus may be never put into power politicians that have a habit of ignoring experts.