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Fiscal Policy in the COVID‐19 Era

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  • Chris Murphy

Abstract

This paper analyses the COVID recession and the large fiscal policy response by modelling scenarios using a macro‐econometric model. The COVID recession mainly arose from lower household consumption of certain services under COVID social distancing. The fiscal response to compensate for income losses in those service industries meant that unemployment was around 2 percentage points lower for 3 years than otherwise would have been the case. However, there was over‐compensation: for every $1 of income the private sector lost under COVID, fiscal policy provided $2 of compensation. Following the end of social distancing, the aftereffects of over‐compensation and over‐prolonged loose monetary policy are modelled to have generated excess demand that temporarily added up to 3 percentage points to the annual inflation rate. Also, three forms of over‐compensation in the JobKeeper program that led the fiscal response created disincentive effects and inequities. The primary lesson for future pandemics is that fiscal policy should compensate, but not over‐compensate, for income losses, both in aggregate and at the program level. The secondary lesson is that monetary policy needs to take more account of the stimulus already provided by the fiscal response, so that interest rates do not remain very low for too long.

Suggested Citation

  • Chris Murphy, 2023. "Fiscal Policy in the COVID‐19 Era," Economic Papers, The Economic Society of Australia, vol. 42(2), pages 107-152, June.
    • Handle: RePEc:bla:econpa:v:42:y:2023:i:2:p:107-152
    DOI: 10.1111/1759-3441.12382
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