Iwan Azis, August 2020

Rethinking Macroeconomics:
Pre & Post Covid-19
Iwan J Azis (ija1@cornell.edu)

- Framework of Evaluation
- Superficial Treatment Of Financial Frictions & Contagion
- Incorporating Health & Epidemics In Macro Model
- Incorporating Inclusiveness In Macro Model

Prepared for Webinar Plenary Session, BMEB Conference,

Ithaca, NY (August 26) – Jakarta (August 27), 2020

Framework Of Evaluation
Macro Forecasting Macro Policy/Planning

Source: Taken from Azis (2018), “Mathematical Models for Economic Analysis”

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Standard Macroeconomics = “A Story” of Equilibrium

u
↑
Say, DM = 10%

Notice that as p↑, i

also ↑ (Fisher hyp) and p↑

Phillips-curve & NAIRU: pt – pt-1 = -a(ut – un)

Okun’s Law: ut – ut-1 = -b(gyt – gy)
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Financial Frictions (FF)

• Assumed agents’ risk behavior • Amplification (measured vs real risks)
(microfoundations) • Contagion & spillovers
• Representative agents & ratex • Incorporating selected “irrelevant”
• Fail to predict pre & post crisis (hence, variables: e.g., inclusiveness, health-
no credible policy guidance) related welfare
Measured Vs Real Risks & Amplification

• EWS
• Stress-test
• etc

Source: I.J Azis & H.S Shin, “Managing Elevated Risk,” (Springer, 2015)
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Financial Frictions (FF) In Macroeconomics

Differentiate financial risk shocks from standard macroeconomic shocks

A Measure of Financial Frictions: US Spread

Following GFC: Which Spread?

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Example Of Trend of Credits in Indonesia:

Actual, With, and Without Frictions (Agency Cost)

Source: Azis (2008, 2019)

Shock Spillovers in Asia: GFC: 310 links

Network (Web) of
Interconnectedness:

Covid-19: 655 links

Source: Azis, Virananda,

Estiko (forthcoming)

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Volatility Spillovers in Asia: GFC: 727 links

Network (Web) of
Interconnectedness

Covid-19: 1032 links

Source: Azis, Virananda,

Estiko (forthcoming)

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Implications
• Modeling: microfoundations (imperfect information, risk
behavior), heterogenous agents, contagion
• Policy: macroprudential, behavior-based & integrated
• Data: Integrate real, social, and financial sector (e.g., FSAM)

See Azis (2018) for further elaboration of the limitations of macro workhorse model
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Financial Social Accounting Matrix

= SAM + Flow-of-Funds

real & social sector financial sector

Modeling
Analysis

e.g., Inclusive
Macro Policy
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In SIR, economic decisions (on C & N) do not influence the dynamics of the epidemics
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SIR-Like Visual Simulation of Covid-19

Paul Romer (2020)
• Model: 50 simulations, 200 symbols, 5 selected at random and assumed
infectious: “S” = blue; “I” = red; “R” = purple, with the following purposes
1. To replicate basic features of more realistic models of epidemiologists
2. To evaluate how different the number of people needs to be
quarantined/isolated for a fixed time period to achieve a cumulative
infection rate <20%, under the following containment policy:
o Uniform social distancing or random isolation (a fixed % pop
randomly selected/day)
o Targeted based on tests (7% pop randomly selected for test/day for
over 500 days; hence 30X in 500 days or once every 2 weeks).
Answer: very different
3. To evaluate how much difference will the results be under different
accuracy of the tests (1% false positive; and 80%, 60%, 40%, and 20%
false negative). Answer: very little
• Adding 1% death rate to “S” does not change the dynamic simulation
results. After some time, isolated “I” (others cannot get close to) turns “R”
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Cumulative Fraction of Pop Infected Current Fraction of Pop Infected (each date)

Baseline: no isolation

Fraction of Population Quarantined Each Date

Source: Paul Romer (2020)

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Cumulative Fraction of Pop Infected With Test Inaccuracy

Test: 80% false negative Test: 60% false negative

Test: 40% false negative Test: 20% false negative

Source: Paul Romer (2020)

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With Containment Policy: Effect On Consumption & Work Hours

Eichenbaum et.al (2020)

Max  weighted avg of lifetime
at time zero

subject to: utility of recovered people (“R”) =

1. Budget constraint of type j person:
2. Transmission function
f = 1 for “S” & “R” and < 1 for “I”
m = tax rate on C (partial containment)
G = Government transfer
equivalent to SIR if

3. Total number of susceptible people “S” at t+1

4. Total number of infected people “I” at t+1

law of motion for
5. Total number of recovered people “R” at t+1 different agents

6. Total number of deceased people at t+1

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SIR Vs SIREC & With Vs Without Partial Containment (m)

SIR
SIREC

“I” has lower peak in SIREC because “S” reduce C & N due to fear of infection. Thereafter, as “S” declines “I” falls too
(fewer “S” to infect). Agg C falls due to: 1) lower productivity & income of “I”; 2) death toll reduces work force & H
Containment
With
Without

‘With’ low containment, infection and death will rise, but lower than ‘without’ containment. The resulting
recession is more severe due to costly C and reduced N. As ‘externality’ becomes important, and
optimal containment rate rises, death flattens with faster recovery.
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SIREC With Strict Containment (Select C & N)

• “I” do not work unless they recover, and their C is set minimum. As a result, all “S”
can work without fear of becoming infected: “I” continues to decline, so does “S”.
Death increases but much smaller than under without and partial containment,
and the initial severe recession will recover steadily.
• Selecting C & N requires policy makers to know the health status of different
people. This can be achieved only through antigen and antibody tests for immunity
and infection that are accurate to act upon, and preferably contact tracing too.
• There are enormous social returns to having tests to implement strict containment
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Possible Extension: With Vaccine & Treatment

Incorporating vaccine & treatment

dv = probability vaccine is discovered

dc = probability treatment is found

Vaccine: if discovered at t* then all “S” becomes “R”. And since no more
“S”, there are no new “I”. Denoting “S’t*” and “R’t*” for after the vaccine,
and For period after t*:

Treatment: if discovered at t* then all “I” becomes “R” and number of

death stabilizes and the number of “S” and “I”
become zero, while the number of “R” is
Law of motion: apply constraints (3), (4) and (5) as before
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Inclusive Macro Policy

Policy choice:
Output Growth AS-PC & AD Price
endogenous shocks endogenous
Inc distribution

Income of Poverty
the poor line
endogenous Poverty endogenous
incidence
endogenous
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Nexus Of Macro Policy-Inequality-Poverty

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Covid-19 Stimulus Policy & Inclusiveness

Dp

Source: Iwan J Azis (2018), “Mathematical Models for Economic Analysis” (UIP)
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• Economic costs are much larger for an open economy

(amplification of international I-O linkages) & higher external debt
suffer worse losses, requiring larger fiscal needs.
• As the key form of GSC financing, reduced capital flows exacerbate
this amplification and contagion (Azis et.al, forthcoming)
• “Traditional macroeconomic tools – stimulating aggregate demand
or providing liquidity to businesses – may have diminished
capacity to restore employment when consumer spending is
constrained by health concerns. During a pandemic, it may be more
fruitful to mitigate economic hardship through social insurance”
(Chetty et.al, 2020)
• “The path forward is extraordinarily uncertain and will depend in
large part on our success in keeping the virus in check” (Jeremy
Powell, 2020)
• Empirical evidence on cross-country income inequality and life-
expectancy………provides little support for the idea that inequality is
a health hazard at the national level (Angus Deaton, 1999)
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Policy Lessons Thus Far

Policy: Uncertainties & Fear Force Sequencing
 Type: [Standard monetary Sequence: card before horse
& fiscal: massive] vs [Non- (test & contact tracing) to make
standard: containment] economic stimulus more
 Space & market reaction: effective
Limited & uncertain!
 Road map: Very few
lessons learned from past
test
history
 External: much less Stimulus
benign, no China lift,
absence of cooperation

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