This week from CEPR: April 23

Thursday, April 23, 2020

Highlights from some of the latest research reports published in the Centre for Economic Policy Research (CEPR) network’s long-running series of discussion papers, as well as some other recent CEPR publications.

Also, links to some of the latest columns on Vox, the Centre’s policy portal, which provides ‘research-based policy analysis and commentary from leading economists’.

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    Roberto Chang, Andrés Velasco                
    CEPR DP No. 14614  | 14 April 2020 

    The success or failure of public policies to fight the Covid-19 pandemic will depend on whether those policies induce socially desirable patterns of behaviour among ordinary citizens. How people choose to behave in turn depends on many factors, including not only expectations of future policies, but also expectations of how other people will respond to those policies.

    These are the central findings of a new CEPR study by Roberto Chang and Andrés Velasco, who develop a minimal economic model of pandemics to understand the feedback loops involving economics, public health and expectations. In their analysis, individuals’ decisions to comply (or not) with virus-related public health directives depend on economic variables and incentives, which themselves respond to current economic policy and expectations of future policies. The analysis yields several practical lessons: 

    • Because policies affect the speed of virus transmission via incentives, public health measures and economic policies can complement each other, reducing the cost of attaining desired social goals. 
    • Expectations of expansionary macroeconomic policies during the recovery phase can help to reduce the speed of infection, and hence the size of the health shock. 
    • The credibility of announced policies is key to ruling out both self-fulfilling pessimistic expectations and time inconsistency problems. 

    Whether or not people adhere to instructions to stay at home is crucial for the number of deaths from the virus. It is less obvious that those individual decisions are likely to be influenced by economic factors and policy incentives. Available for free download here >>>  

    • BEHAVIOURS AND PERCEPTIONS IN THE COVID-19 PANDEMIC: Analysis from a global survey    

    Stefano Caria, Thiemo Fetzer, Stefano Fiorin, Friedrich Goetz, Margarita Gomez, Johannes Haushofer, Lukas Hensel, Andriy Ivchenko, Jon M. Jachimowicz, Gordon Kraft-Todd, Elena Reutskaja, Christopher Roth, Marc Witte, Erez Yoeli        
    CEPR DP No. 14631 | 17 April 2020

    A large-scale survey covering 58 countries and over 100,000 respondents reveals that people across the world are responding strongly to the Covid-19 pandemic, both in terms of their own behaviour, as well as their beliefs about how their fellow citizens should react to the crisis. A majority of respondents also believe that their governments and fellow citizens are not doing enough, which heightens their worries and depression levels.

    These are the central findings of a new CEPR study by Thiemo Fetzer and colleagues, who take survey data from late March and early April 2020 to study beliefs and attitudes towards citizens' and governments' responses to the Covid-19 pandemic. Among the findings: 

    • Most respondents reacted strongly to the crisis: they report engaging in social distancing and hygiene behaviours, and believe that strong policy measures, such as shop closures and curfews, are necessary. 
    • They also believe that their government and their country's citizens are not doing enough and underestimate the degree to which others in their country support strong behavioural and policy responses to the pandemic. 
    • The perception of a weak government and public response is associated with higher levels of worries and depression. 
    • Strong government reactions correct misperceptions, and reduce worries and depression. 

    These findings highlight that policy-makers not only need to consider how their decisions affect the spread of Covid-19, but also how such choices influence the mental health of their population.


    Facundo Piguillem, Liyan Shi       
    CEPR DP No. 14613 | 16 April 2020

    If a government does not have the means to identify the carriers of the virus, the observed mandatory quarantines around the world seem to be close to what it can be considered optimal. But if the government can increase the intensity of testing, that is a far superior strategy. 

    These are the central findings of a new CEPR paper by Facundo Piguillem and Liyan Shi, which attempts to understand the optimal response to an infectious disease, such as Covid-19. Among the findings: 

    • Observed policies are very close to a simple welfare maximisation problem of a planner who tries to stop the diffusion of the disease. 
    • These extreme measures seem optimal in spite of the high output cost that it may have in the short run, and for various curvatures of the welfare function.
    • The desire for cost smoothing reduces the intensity of the optimal quarantine while extending it for longer, but it still amounts to reducing economic activity by at least 40%. 

    The authors also explore the possibility of either complementing or substituting the quarantine policy with random testing. The results show that testing is a very close substitute for quarantine and can substantially reduce the need for indiscriminate quarantines. Available for free download here >>>  


    Massimo Motta, Martin Peitz             
    18 April 2020

    State aid is essential to reduce long-run harm to the EU economy as a result of the Covid-19 crisis. But non-harmonised programmes across EU member states generate serious risks to the functioning of markets, particularly if they go beyond short-term liquidity provision or employment support. 

    Writing at Vox, Massimo Motta and Martin Peitz suggest imposing strict conditions on state aid for recapitalisation of firms and argues in favour of an EU-wide programme for critical sectors. Such a programme would prevent harmful market distortions and maintain a level playing field for EU companies.

    MITIGATING COVID-19 PANIC BUYING: Lessons from historical financial crises

    Kilian Rieder             
    20 April 2020

    Why does panic buying arise during crises such as the Covid-19 pandemic, and how may one mitigate its negative consequences? A study by Kilian Rieder examines the Bank of England’s response to financial crises in the nineteenth century and suggests that a key action is to counter those incentives that turn panic buying into a rational strategy by making it blatantly unnecessary.


    Rabah Arezki            
    20 April 2020

    Covid-19 will precipitate ‘peak demand’ for oil with dramatic consequences for oil-exporting countries in the short and medium run. Writing at Vox, Rabah Arezki provides a perspective on the role of monetary policy in these countries at different horizons: 

    • In the short run, (independent) monetary policy should flexibly target inflation. 
    • In the medium run, central banks need to coordinate with fiscal authorities to ensure that monetary policy operates around a credible and sustainable fiscal anchor. 
    • In the long run, central banks should beware of the existential threats posed by new risks related to stranded assets.


    Titan Alon, Matthias Doepke, Jane Olmstead-Rumsey, Michèle Tertilt            
    19 April 2020

    The lockdowns triggered by Covid-19 are taking a disproportionate toll on women in the labour market, as sectors with high rates of female employment are experiencing heavier job losses while increased childcare needs during school closures exert an outsized impact on working mothers. But a study by Michèle Tertilt and colleagues finds reason to hope that by promoting flexible work arrangements and putting the childcare obligations of both genders into plain sight, the crisis may reduce labour market barriers in the long run.  


    Johannes Ehrentraud, Denise Garcia              
    19 April 2020

    A study by Johannes Ehrentraud and Denise Garcia examines policy responses to fintech developments in approximately 30 jurisdictions worldwide and proposes a novel conceptual framework – the ‘fintech tree’ – that distinguishes three categories: fintech activities; enabling technologies; and policy enablers. Designing a policy framework for fintech will require finding a balance that maximises its benefits while minimising potential risks to the financial system.

    TAX EVASION IN THE REAL ESTATE SECTOR: Using appraisals as a red flag

    José García-Montalvo, Amedeo Piolatto, Josep Raya              
    19 April 2020

    Tax evasion is a persistent problem across countries, with fraudulent behaviour especially common in the real estate sector. Writing at Vox, José García-Montalvo and colleagues argue that tax authorities should use appraisals to identify potentially fraudulent real estate transactions. Transactions with an appraisal value that is low compared with the sales value are shown to have a higher likelihood of involving fraud. This is because low appraisals indicate an unconstrained buyer who, in contrast to a liquidity-constrained buyer, is able to afford an (illegal) side payment to lower the sales value and thus the tax payment without resorting to a high mortgage.

    CREDIT AND TRADING BEHAVIOUR: New evidence from the South Sea Bubble

    Fabio Braggion, Rik Frehen, Emiel Jerphanion         
    19 April 2020

    How does cheap credit feed into investors’ behaviour? Cheap credit could boost stock prices, even without trading, by lowering the cost of capital. But it might also enable naïve investors to ride a bubble and lose money. To see what effect prevails, a study by Tilburg economists collects every stock transaction for three major British companies during the 1720 South Sea Bubble. It finds that loan holders are more likely to buy following high returns, subscribe to overvalued share issues and incur large trading losses.

    ON THE LEGACY OF FINANCIAL CRISES: Lessons from Mexico’s sudden stop history

    Gianluca Benigno, Andrew Foerster, Christopher Otrok, Alessandro Rebucci             
    19 April 2020

    A study by Alessandro Rebucci and colleagues shows that financial crises are often followed by a quick but partial rebound. Thereafter, economies can experience a very protracted period of stagnation. A similar trajectory may be likely for the current Covid-19 crisis, as many countries will face financial frictions in responding to the economic downturn.


    Rui Esteves, Nathan Sussman           
    18 April 2020

    After an initial lull, financial markets reacted with a vengeance to the Covid-19 pandemic. Comparisons with 2008 are inevitable, but the ultimate impact on markets is still unclear. Writing at Vox, Rui Esteves and Nathan Sussman argue that the spread of the pandemic has little explanatory power over financial stress. 

    Markets reacted to Covid-19 as in any international financial crisis by penalising emerging economies (and countries without credible monetary anchors), exposing age-old vulnerabilities. This finding highlights the need for credible, but flexible, sovereign currencies and the need to build up liquidity reserves.


    Nicola Pierri, Yannick Timmer       
    18 April 2020

    Banks that adopted IT more intensely before the Global Crisis were significantly more resilient when the shock hit. These banks had significantly fewer non-performing loans, and issued more loans during the crisis itself. Loan-level analysis indicates that high IT adoption banks issued mortgages with better performances and did not offload low-quality loans. These are the findings of a new study by Nicola Pierri and Yannick Timmer, which analyses the implications of lenders' information technology adoption for financial stability.


    Reshad N Ahsan, Laura Panza, Yong Song            
    18 April 2020

    A new study examines the relationship between Atlantic trade and war in Europe between 1640 and 1896, a period in which intra-European conflict decreased dramatically. It finds that the growth in Atlantic trade lowered the probability of intra-European conflict by 15 percentage points. While the relationship between trade and war is ambiguous, some argue that diminished trade can pose a threat to global peace by lowering both the opportunity costs of war and the cost of raising an army.  


    Benjamin Enke, Thomas Graeber            
    18 April 2020


    Writing at Vox, Benjamin Enke and Thomas Graeber argue that cognitive uncertainty predicts economic actions and beliefs because, in binary settings, it induces people implicitly to compress probabilities towards a 50:50 ‘mental default’. This partially explains behavioural anomalies in choice under risk, choice under ambiguity, belief updating, and survey forecasts of economic variables. 


    Nils Karlson, Charlotta Stern, Daniel Klein          
    20 April 2020

    Sweden has largely bucked the lockdown trend, leaving much to the discretion of individual citizens. Writing at Vox, Nils Karlson and colleagues detail some of the institutional and cultural underpinnings of Sweden’s Covid regime, and explain why the country has opted for a relatively permissive approach.


    Andrew Lilley, Kenneth Rogoff         
    17 April 2020

    In the aftermath of the Global Crisis, conventional monetary policy has been constrained by low interest rates in many major economies. This has spurred debates about the possibility of introducing negative interest rates in the monetary policy toolkit. 

    A study by Andrew Lilley and Kenneth Rogoff uses evidence from the United States to show that not only do the markets expect the low interest rates to persist into the future, but they also expect the use of negative interest rates down the line. Moreover, markets no longer believe that even quantitative easing can bring inflation to target, which leaves very few alternatives for monetary policy apart from negative interest rates.

    RAMPING UP VENTILATOR PRODUCTION: Lessons from the Second World War

    Ethan Ilzetzki, Hugo Reichardt           
    17 April 2020

    Governments worldwide have called on non-specialist firms to produce medical ventilators. Writing at Vox, Ethan Ilzetzki and Hugo Reichardt draw three lessons from US munition production in World War II: 

    • Ramping up production takes time, particularly for non-specialist producers. 
    • International cooperation is needed to share knowledge about production technology and supply chains. 
    • Direct public investment in plant expansions should be part of the strategy.

    IS THE UNITED STATES LOOKING LIKE ITALY? Projections on Covid-19 death rates

    B. Ravikumar, Guillaume Vandenbroucke          
    17 April 2020

    A study by B. Ravikumarand Guillaume Vandenbroucke uses the actual number of Covid-19-related deaths to calculate projections for the United States based on other countries’ experiences. While US numbers exceeded Italy’s in the total number of deaths as of 11 April, the number of daily deaths adjusted for population is less in the United States than in Italy. But the general trend over the last four weeks suggests that the United States seems to be on its way to catching up with Italy on that metric.  


    Carlos Garriga, Matthew Famiglietti           
    17 April 2020

    How might Covid-19 affect the liquidity and pricing of housing and mortgage rates? A study by Carlos Garriga and Matthew Famiglietti finds that lower demand for housing while supply is at a historically high level is likely to have an adverse impact on the start of the spring house hunting season. If the economic fallout from Covid-19 continues longer than a few months, more expansive protections may be required. 


    Richard K Lyons, Ganesh Viswanath-Natraj             
    17 April 2020

    Does stable coin issuance have an inflationary effect on cryptocurrency prices such as Bitcoin? A study by Richard Lyons and Ganesh Viswanath-Natraj argues that aggregate stable coin issuance does not drive crypto prices, in contrast to claims from previous studies. Instead, issuance behaviour can be explained as maintaining a decentralised system of exchange rate pegs and acting as a safe haven in the digital asset economy. The latter can be demonstrated by the significant stable coin premiums during the Covid-19 panic of March 2020.

    CIVIC CAPITAL AND SOCIAL DISTANCING: Evidence from Italians’ response to Covid-19

    Ruben Durante, Luigi Guiso, Giorgio Gulino             
    16 April 2020

    Social distancing slows the spread of Covid-19. In regions that adopt social distancing practices early (before receiving explicit stay-at-home guidelines from their governments), the virus can be contained more quickly. Using Italian data from phone location tracking of movements made by individuals after the pandemic began, Ruben Durante, Luigi Guiso and Giorgio Gulino find sharper drops in mobility in areas with higher ‘civic capital’, suggesting that civic values can mediate the social distancing process. The evidence suggests that differences in civic culture can significantly affect the effectiveness of social distancing policies aimed at containing the propagation of the virus.  


    Hiroyasu Inoue, Yasuyuki Todo             
    16 April 2020

    A new study by Hiroyasu Inoue and Yasuyuki Todo examines how the economic effect of the lockdown of a city can propagate to other regions in the country, focusing on Tokyo. The findings suggest that if Tokyo were to be locked down for two weeks, the loss in value added production in the city would be 4.3 trillion yen, while the production loss in the rest of Japan due to propagation through supply chains would be 5 trillion yen. In addition, the effect on other regions becomes progressively larger as the duration of the lockdown grows.

    CORONABONDS: The forgotten history of European Community debt

    Sebastian Horn, Josefin Meyer, Christoph Trebesch              
    15 April 2020

    Will the introduction of European coronabonds create a dangerous precedent of debt mutualisation? Writing at Vox, Christoph Trebesch and colleagues argue that this view is wrong and ignores the history of European financial cooperation. Since the 1970s, the European Commission has placed more than a dozen community bonds on private markets, which were guaranteed by the member states and distributed to countries in crisis. These bonds have been fully repaid in the past. Coronabonds with joint and several liability go a step further, but they would stand in a long tradition of European financial solidarity and cooperation. 


    Giorgio Gobbi, Francesco Palazzo, Anatoli Segura              
    15 April 2020

    Most governments have introduced temporary credit guarantees to ensure banks can provide the liquidity needed by firms during the Covid-19 crisis. Writing at Vox, economists from the Bank of Italy argue that these policies create incentives for banks to foreclose guaranteed loans maturing close to the expiration date of the guarantee scheme. This hidden effect is worse for firms whose debt is set to increase substantially during the pandemic. To avoid foreclosure ‘waves’ on the eve of the public guarantee termination, complementary measures that reduce firms’ debt burden should also be adopted.


    Antonio Accetturo, Michele Cascarano, Guido de Blasio              
    15 April 2020

    From the sixteenth to the early nineteenth century, coastal areas of Italy (especially in the south-west) were subject to attacks by pirates launched from the shores of northern Africa. To protect themselves, residents of coastal locations moved inland to mountainous and rugged areas. A study by Bank of Italy economists shows how relocation constrained local economic development for a long period after the piracy threat had subsided and may have had aggregate consequences on Italy’s development after World War II.  


    Vesa Vihriälä               
    15 April 2020

    Writing at Vox, Vesa Vihriälä argues that debt relief by the European Central Bank would allow all member states to finance the necessary fiscal measures to counter the Covid-19 crisis in a normal fashion. While effectively forgiving past debt would create expectations that the same could happen again in the future, this moral hazard should be weighed against what is likely to happen without such relief. 


    Romina Gambacorta, Alfonso Rosolia, Francesca Zanichelli            
    15 April 2020

    A new study by Bank of Italy economists uses survey data on European households’ balance sheets to demonstrate that across European countries there are large (and similar) shares of the population that are likely to suffer from the economic fallout of containment measures – albeit through different channels – and that, were the lockdowns to last three months, might not have sufficient financial resources to maintain a minimum threshold of wellbeing. The need for household support measures will most likely be felt throughout Europe.


    Mariarosaria Comunale             
    20 April 2020

    A new study by Mariarosaria Comunale sheds light on shock-dependent exchange rate pass-through for the euro area and its member states by drawing comparisons and looking at the robust results across the available structural empirical frameworks and theoretical models. It finds that different domestic and global shocks can be associated with widely different pass-throughs, but these are similar across models, with the largest value experienced in the case of monetary policy shocks.


    Debraj Ray and Lore Vandewalle       

    On 24 March 2020, the government of India ordered a nationwide lockdown of 1.3 billion people for 21 days as a preventive measure against Covid-19. Given what we know of the epidemic, it is difficult to quarrel with the prescription of social distancing and lockdown, when accompanied by state measures that provide adequate economic protection, but what happens in countries where the state is unable to provide the necessary back-up welfare measures?

    Debraj Ray (NYU) and Lore Vandewalle (IHEID) discuss the ideas presented in the CEPR Policy Insight they recently authored (together with Sreenivasan Subramanian). Download the paper here.

    COVID-19: Science versus politics

    Frédéric Jenny       

    Politicians want to add credibility to their decisions through presentation of supporting scientific advice. The difficulty with this in the Covid-19 crisis is that scientists don't always have concrete answers and can feel pressured by politicians to go beyond what is actually known. Frédéric Jenny (ESSEC Business School, OECD) has contributed a paper to CEPR's new Covid Economics Review, which you can download free here

    COVID-19: Propping up failures

    James Bullard     

    In the United States, around 1,600 firms go out of business in a normal day. James Bullard, Federal Reserve Bank of St. Louis, thinks there is little chance of businesses that were about to go under before the pandemic being shored up by the measures being taken to protect the US economy. His view is that whatever economy we had on 1 February, we want that economy on the other side of the pandemic.


    Frédéric Jenny       

    Politicians have trade-offs to make when it comes to Covid-19. Lockdown is an effective but costly life-saving 'treatment', but at what point does the cost outweigh the lives saved? Frédéric Jenny (ESSEC Business Scool, OECD) has contributed a paper to CEPR's new Covid Economics Review, which you can download free here >>>

    COVID-19: Write off Q2

    James Bullard       

    James Bullard, Federal Reserve Bank of St. Louis, considers current estimates that work-from-home output might be 90% of normal output to be over optimistic. His suggestion is that we should stop worrying about growth rates for Q2 and just write it off.

    COVID 19: Lives versus lives

    Lore Vandewalle       

    In India, the trade-off the government is facing is not lives versus the economy when it comes to fighting Covid-19, but lives versus lives. The aim is not to lose more people to the containment measures than the virus would claim without them. Lore Vandewalle (IHEID) is a co-author of CEPR Policy Insight 102, India's Lockdown.


    James Bullard       

    The actions and policies taken to control the spread of Covid-19 in the United States have had the effect of engineering a controlled, partial and temporary shutdown of certain sectors of the economy. James Bullard, Federal Reserve Bank of St. Louis, tells Tim Phillips about the implications of theses radical changes to the management of the US economy in the near term.

    COVID ECONOMICS: Resilience and governance

    Frédéric Jenny       

    Frédéric Jenny (ESSEC Business Scool, OECD) talks about his recent study in CEPR's new Covid Economics Review, 'Economic resilience, globalisation and market governance: Facing the Covid-19 test' The full paper is available here >>>

    COVID-19: The politics of visibility

    Debraj Ray        

    Governments have a tendency to prefer minimising visible dangers. A tight lockdown reduces visible deaths from Covid-19, but brings with it diffuse, and relatively invisible deaths (for example suicide, domestic violence). Debraj Ray (NYU) is co-author of CEPR's Policy Insight 102: India's Lockdown.