Essay: The Pandemic and the Macroeconomic Shock Induced by Containment Policy

announced that for at least the next three weeks the UK would be in lockdown. People were to remain in their own homes only to leave for; work, if it could not be done at home, daily exercise and essential shopping. Understandably this threw the global economies into what can now be described as macroeconomic shock.


The pandemic 
The reproductive rate (R) is a key parameter used when modelling infectious diseases. In the early stages of coronavirus, it was estimated that the R rate was 2.5, this means every infected person spreads the disease on average to 2.5 other people. With a growth rate of 150%, the epidemic would grow at an exponential rate until the susceptible population reduces through death or recovery. Coronavirus is a new disease and hence there is limited herd immunity, so without the imminent promise of a vaccine, the only way to prevent the spread is social distancing. By letting the virus run its course and not imposing strict social distancing measures, it is estimated the 35-70 million people would die globally, based on the current death rate of between 1 and 2% of infected people dying. However, with the additional parameter of distance, we can understand how these numbers can be drastically reduced. The graphs show that increasing the distance between people (Dt) reduces the reproductive rate, hence controlling R.  


This delays onset and peak of the virus, as well as lowering the maximum point, meaning fewer people will require medical assistance and the health service will not be overwhelmed. Although this would mean the virus decays at a slower rate, the curve is significantly flattened meaning less need to rely upon the herd immunity we do not yet have. Never before have policies of social distancing been used so we have no way of knowing whether it works and still face the risk of not distancing enough resulting in billions still being infected. This is why the UK government is requiring a nationwide maximum R-value of 0.6 before any lockdown measures can be lifted. Even with the relatively low-cost test without knowing exactly who is infected, as the cost of this would be the cost of testing the entire population. In the absence of this knowledge, the government must implement social distancing on the whole population, hence inducing macroeconomic shock. This will have a major and lasting impact on the economy and is likely to lead the UK and many other nations into recession.


Macroeconomic shock induced by containment policy 


An economic shock is an unexpected economic event, they can often have significant effects on key macroeconomic policy. Particularly in the UK because the United Kingdom is closely integrated into the wider global economy. Global developments and crisis, therefore, affect the economic fortune of the UK greatly. External shocks can affect all aspects of the economy including:
Aggregate demand (C+I+G+X-M)
Aggregate supply 
Product markets for goods and services 
Labour markets 
Financial markets 
The scale of these shocks and their effects will always vary between countries, but a key feature is that they will always affect confidence. This is exactly what we have seen following the global outbreak of COVID – 19. There are two main types of global shocks;
Supply shocks, these affect the global supply and prices of goods and services, these types of shocks move the Phillips curve by changing the labour market equilibrium
Demand shocks, these are associated with a rise or a decline in spending and confidence abroad
The containment policy being used to control the coronavirus has shut down economic activity, we are already seeing the following as a result: 
 Productivity shocks because closing businesses have reduced levels of production and increased unemployment. Causing the Philips curve to shift down. 
Inflation shock because a reduction in supply could result in shortages in the supply chain. inflating the general cost of goods in the economy and causing an upwards shift in the Philips curve. 
Shock to aggregate demand meaning households reduce spending, there are higher levels of uncertainty and levels of world trade contract all leading to the aggregate demand curve shifting down. Which is further amplified by the multiplier effect of exogenous aggregate demand.
COVID -19 has been described by some economist as a Keynesian supply shock, a supply shock that triggers aggregate demand changes larger than the initial shock. The job destruction and destruction of firms have amplified the initial shock and are now likely to aggravate the recession that will likely follow. Under the theory of Keynesian supply shocks, standard fiscal policy is less effective than normal, because some entire sectors are shut. The opposite is true of monetary policy, and in fact, the Keynesian multiplier effect can magnify effects of monetary policy. 


Macroeconomic Response 
Faced with the real prospect of economies grinding to a halt, as a result of containment policies; around the world, central banks and governments have been announcing plans for support packages to ease the effects on the economy. All in hope of flattening the recession curve.


Monetary policy response 
On the 12th March, the Bank of England took their first action, to cut interest rates from 0.75% to 0.25% following a unanimous vote by the Monetary Policy Committee. This being the first emergency cut since the 2008 financial crisis. The rates were subsequently cut further to only 0.1%, their lowest recorded level. The transmission mechanism of monetary policy explains the ways changes to interest rates on aggregate demand, prices and output. 
When the Bank of England decreases the base rate the commercial banks will typically reduce the cost of taking out a loan through the reduction in interest rates. The aim is to encourage businesses and individuals to take out loans to encourage spending and investment, hence inflating aggregate demand, and stimulating demand and output. Ultra-low interest rates like we are seeing now and what we saw during the 2008 financial crisis are an example of expansionary monetary policy. In theory, cutting policy rates so close to zero should provide major monetary stimuli. Those with a mortgage will have reduced payments effectively increasing their disposable income. The cost of credit to the consumer falls encouraging the purchase of more expensive items like cars. The housing market may see an increase in purchases as cheaper loans making houses are more affordable. Businesses will not be under as much pressure to meet credit payments on loans. All around the lower rates are meant to boost consumer and business confidence. However, it is argued by some analysts that under the current circumstances lowering interest rates has little impact on demand. There have been many reasons put forward for why this may be the case. Due to the relatively high price to banks to loan, many of them have become risk-averse and reduce the size of their loan books making it harder for somebody to get a loan even if under the interest rates they would be able to afford it. Another reason is that when a financial downturn is imminent consumers have little confidence and are unlikely to want to commit to a large purchase when their jobs may not be secure and the economy is unpredictable. To combat these problems and maximise the effectiveness of low-interest rates, the Bank of England have announced a new Term Funding Scheme for Small and Medium-sized Enterprises (TFSME). This scheme is to help reinforce the reduced interest rate in the real economy ensuring businesses and households can benefit. 


In addition to cutting interest rates, the Bank of England is encouraging spending further through a policy of Quantitate easing. Quantitate easing is a tool used by central banks to inject money into the economy. Quantitate easing involves the creation of digital money to buy government debt in the form of bonds. Large purchases of government bonds lower the interest rates on those bonds pushing down interest rates offered on loans. Hence making it cheaper for businesses and households borrow money. The Bank of England has announced a £200bn qualitative easing programme in response to Covid-19. This and the cuts to policy rates aim to support jobs and growth in the UK and hopefully will smooth the economic downturn and allow business to return to normal when social distancing measures are lifted. However, in a crisis such as COVID-19, the problem is not liquidity, but the ceasing of any economic activity. The actions of the Bank of England are therefore important but not sufficient. Governments must implement heavy fiscal policy changes if the recession curve will truly be flattened.


FISCAL POLICY RESPONSE 
The primary goal for fiscal policy at present should be to cushion the downward shock as much as possible, ensure the delivery public service and set the conditions for the economy to bounce back after the restrictions on economic activity are removed. 


Primarily the coronavirus will present additional challenges for some public services. Rishi Sunak announced support for these services amounting to £5billion package for the coming year specifically for NHS and social work, he also indicated that should this not be enough more finance could be available. 


An individual that may be hurt by falling incomes as a result of the containment policy or their illness is the next area the chancellor addressed. Although the government already has a policy of statutory sick pay, for this coming year small employers will be entitled to a rebate of these costs. This ensures they will not be unduly impacted. The government has come under criticism for this as the rebates will not be organised for a few months and for cash strapped businesses who may have lost both business and workforce this may be too late. 
For those facing a more general fall in their income, universal credit is available. The policy announced, people will be able to claim universal credit and get an advance on their payment without visiting a job centre, adhering to lockdown measures. This has never been used in a nationwide economic downturn so may face new challenges but funding has been set aside to deal with it. These measures ensure that even those on the lowest income can afford to continue spending, which is imperative to smoothing the recession curve.


Finally, the government announced a range of policies offering support to businesses that would otherwise have been productive but can’t either due to a contraction in supply or demand. These businesses will, following the alleviation of lockdown and social distancing, be fundamental in rebuilding the economy. The government’s policy suggests they are particularly concerned for business suffering a temporary drop in demand, to target this the government announced a temporary cut in business rates for businesses in hospitality, leisure and retail. 
 
The graph shows this cut along with previous cuts unrelated to coronavirus. Qualifying businesses receive a 100% tax relief. Affecting an estimated 200,000 businesses nationally. The graph shows that the businesses already exempt from these rates will receive a £3000 grant. Pubs would not benefit from these reliefs so will receive a £5000 discount in the coming year. 






The Furlough scheme is another important part of the fiscal policy response. This is to pay up t to 80% of wages of people who would otherwise lose their jobs, reducing the strain on employee relationships and improving the solvency of businesses adversely affected by coronavirus. The scheme was originally supposed to end in July, however, this was since extended to October 2020 and is already covering 7.5million jobs, 25% of the UK’s working population. The scheme means that rather than laying off worker companies can furlough them and the Government will pay a maximum of 80% of their salary. 
Overall the government’s fiscal policy to expand healthcare services, support solvent businesses and help household finances will all aid in the flattening of the recession curve caused by Covid-19.