The macroeconomics of Covid-19

Covid-19 is now spreading rapidly in all the major economies of the world. The economic impact of this will be large and almost certain to cause a recession. The uncertainty around the virus is undermining business confidence, which is reflected in fall the falling stock market and declines in investment.

Getting a grip on the likely impact of Covid-19 is a daunting task for economists. There is much we don’t know about the virus at this point. But what is clear is that this is the first time in two generations that the United States is facing an illness that is significantly affecting economic activity.

It is hard to find an analogy for our current circumstances. Some are comparing Covid-19 to natural disasters like earthquakes and weather events. But the comparison is not perfect, as the course of natural disasters is predictable. Earthquakes end quickly; weather events are over in a few days. How the current plague will play our is unclear. Many think the pandemic will dissipate with warmer weather as with other coronaviruses, but who knows?

The seven largest economies, often referred to as the G7, are now seeing the spread of the disease. Among these China, of course, was the origin of the outbreak, and appears to be past the worse. Meanwhile, Italy is on lock down. The other G7 countries are taking various actions with differing impact on daily life. These countries collectively represent about two thirds of the world economy.

Determining the macroeconomic impact of Covid-19 is difficult to estimate. The primary effect of Covid-19 will be on the supply side. Workplace shutdowns, voluntary self-isolation, slowdowns in deliveries, and restrictions on travel will decrease production and increase costs.

The spread of the disease—especially to China, Korea, Japan, Germany and the United States—is disrupting the global supply chain, with negative consequences for economic activity in nearly all countries.

A supply shock like Covid-19 results in stagflation, the combination of inflation and stagnation. There is likely to be both a decline in output and an increase in prices. Dealing with this is difficult, because policies designed to help with unemployment aggravated inflation and policies that fight inflation aggravate unemployment. It is a no-win situation. One can only balance the tradeoff among bad options.

Covid-19 is dragging down the economy, but the rapid decline in oil prices, while bad news for New Mexico, is a positive. Lower energy prices will offset the shock of Covid-19.

Twenty years ago, when the United States was a large energy importer, the decline in oil prices would have been an unequivocal positive. Today, we import about as much as we export. So lower oil prices benefit us by reducing the cost of imports, but harm us by reducing the profitability of domestic producers. The net effect of lower energy prices is a mild stimulant to the U.S. economy.

Donald Trump has staked his reelection on the strong economy. This was a good strategy prior to Covid-19. Lower oil prices will partially rescue Trump from the negative effects of the virus, so it appears that Crown Price Mohamed bin Sultan’s decision to cut prices and increase production could be decisive in our election outcome.

Christopher A. Erickson, Ph.D., is Carruthers Chair of Economic Development at NMSU. He has taught money and banking for 35 years. The opinions expressed may not be shared by the regents and administration of NMSU. He can be reached at chrerick@nmsu.edu.