Conventional macroeconomic policies and the pandemic-driven recession

We build a three-country DSGE model to address the economic fallout from the COVID-19 shock with and without the economic authorities’ reaction. In the latter case, three different scenarios are drawn: optimistic, baseline, and pessimistic scenarios. We find that the pandemic brings about a prolonged economic depression in the pessimistic scenario, as GDP and hours worked fall by 20% (from trend) and they never recover their pre-crisis levels over the span of time studied. Interestingly, the supply-side effects dominate the demand-side ones, which leads to inflationary pressures on a temporary basis. In the base scenario, output and hours worked decline by 10% and deflation kicks in, but the economy goes back to the initial steady-state faster than in the preceding setting, roughly after two years. As for the optimistic one, the effects of the shock on output and hours worked are relatively mild and short-lived. We then move on to analyze the effectiveness of a collection of fiscal and monetary policy tolos in curbing the recessionary consequences of the pandemic. The most powerful instruments are government purchases and expansionary monetary policy, although these two measures come with some trade-offs. A labor-income tax cut can also play an important role in helping the economy return to its steady-state levels. The remaining tax policies seem to have small effects on the economy.