Panic is here.
People are going crazy.
What started as a strange virus “attacking” far away countries is now our nightmare, something that is among us and is able to “end with our life” (maybe not literally but as known now)
Obviously, this is not a problem which can be reduced to a simple aspect, these phenoms affect everyone’s daily life in an unpredictable way, and maybe because of that, society is acting without common sense.
Where are we going to?
For what we know so far, this crisis might have its biggest effect on events such as sports, concerts and festivals and of course on the economy in general (obviously if we take into account the whole world and not just the most affected areas).
Many of us understand that postponing events is a preventive measure. This implies people keeping away from crowds and prevents a huge amount of people from getting “infected”. Therefore, this measure may help authorities control the virus evolution in a more efficient way. But, why will the economy suffer such a big recession? Why are the governments applying new an “unexpected measures? Well, this might have an explanation if we look at the economic basic models.
The most accurate economic model to explain this situation is the IS-LM-PC model, where the equilibrium of goods market is given by the IS curve, the equilibrium in money market by the LM curve and the relationship between unemployment and inflation by the PC curve.
The scenario nowadays can be described as one of an uncertain period. No one knows how our lives will change, how to react to this crisis and how safe we are. These doubts are transferred to the market, where investors think that they are taking more risk when they invest in an asset, and because of this they will not be compensated enough for their investments. Therefore, they are investing less, waiting for a more easily predictable time to avoid losing the invested capital, and therefore currently they prefer to invest in safer assets such as gold.
Moreover, consumption is decreasing as well, which entails a big decrease in GDP (that can be understood as production and income too). This implies a reduction in the economic activity in general’, which is also visible regarding the decrease in inflation.
(Not) Expected Measures
Governments must look for their citizens’ wellbeing and this includes both economically and socially, so nobody should be surprised if they take measures affecting our day-to-day that we would have not expected before the beginning of this crisis.We have all read in the media about how improvised and surprising measures taken by some governments in the most industrialized countries have been, but personally I understand that these are the most logical ones. Just like governments try to control social development, they should guarantee GDP at its natural level and, to get that, there is a “manual of instructions” to follow.
In situations like this, governments are meant to stimulate the economy again and to restore the GDP level. For that reason, the European Central Bank (onwards, “the ECB”) should print more money and introduce it into the market circulation buying bonds. With this, they would reduce the interest level and let everyone make transactions easier. See it graphically.
Firstly, consider this graphic as the representative one when everything started.
-As we said before, the IS curve is determined by consumption [C] (that depends on GDP, production or income [Y] and taxes [T] ) and investments [I] (that depends positively on Y and negatively on interest rate [r] and the risk premium [x], but there is government spending too [G].
– To simplify LM relation, we take the interest rate as given and constant.
– The equilibrium point of both markets determines the Yn (GDP natural level), that the value it should take in ordinary conditions.
Regarding what we explained about what happened:
– We said that risk premium [x] increased and consumption (C) and income (Y) decreased “at the same time”.
These changes imply a shift to the left of the IS curve that causes a level of the GDP (and the inflation) below its natural level.
Secondly, we concluded that, in order to restore the economy starting level, new measures should be applied, which can come from the government (increasing public spending and reducing taxes) shifting the IS curve up or the ECB (decreasing the interest rate, which shifts the LM down).Those measure taken by the authorities would help reactivate the economy.
Why is this phenom affecting the entire world?
The answer to this question is globalization, which represents the process of interaction and integration among people, companies, and governments worldwide.
Economically, globalization involves goods, services, economic resources of capital, technology, and data. All improvements in these areas have generated a huge interdependence of economic development. So, for example, the 2008’s crisis originated in US affected first the UK (due to their close economic links) and then the rest of Europe.
Nowadays, there is no country able to develop their economy by itself, like an autarchy, and as it occurs with goods and economic well-being, feelings are also exchanged among developed countries by the markets (local sense of risk and uncertain affects the market, that will affect others) and this generates a huge controversy. Countries need people and good exchanges to continue with their economic activity, but at the same time they should keep making decision that assure people’s health not being put at risk
Once everyone understands what is happening, we will have to try living ordinarily without panicking and keep on with our daily routines as much as we can. There is nothing we can do except for following the authorities’ instructions and be aware of what we are doing and what the new reality might be.
Enrique Martín, student of 1st year of the Degree in Economics in Pompeu Fabra University in Barcelona and collaborator in the blog Pompeunomics.