Optimal federal redistribution during the uncoordinated response to a pandemic

Optimal policy during an epidemic calls for depressed economic activity to slow down the outbreak. Sometimes, these decisions are left to local authorities (e.g. states). This creates an externality, as the outbreak doesn’t respect states’ boundaries. A strategic Pigouvian subsidy that rewards states which depress their economies more than the average corrects that externality by creating a race-to-the-bottom type of response. In equilibrium nobody receives a subsidy, but the allocation is efficient. If local authorities are concerned about unequal burden of the lockdown costs but cannot easily issue new debt to finance transfer payments, then lockdowns will be insufficient in some areas and excessive in others. When that’s the case, federal stimulus checks can flatten the infection curve.