Macroeconomic Policy to Aid Recovery after Social Distancing for COVID‐19

• Author: Ian M. McDonald
• DOI: http://doi.org/10.1111/1467-8462.12387
• Published date: 01 September 2020
• Date: 01 September 2020

The Australian Economic Review, vol. 53, no. 3, pp. 415–428 DOI: 10.1111/1467-8462.12387

Macroeconomic Policy to Aid Recovery after Social Distancing

for COVID‐19

Ian M. McDonald*

Abstract

Using the Keynesian model set out in

McDonald (2020), in which downward wage

rigidity is supported by worker loss aversion

with respect to wages, this article shows that a

period of social distancing (SD) can leave a

post‐SD economy with both stimulatory and

depressive effects. A loss of productive

capacity is stimulating. Costs of restarting

firms, lower labour productivity when re-

started and a desire to restore wealth from

debt incurred during the period of SD are

depressive. If, as seems highly probable, the

net effect on economic activity is negative then

afiscal expansion can restore activity. To

avoid an increased government budget deficit,

this expansion would probably require an

increased tax rate. Reductions in real wages

may also be necessary. A desire to balance the

government budget combined with no in-

crease in the tax rate would be unfortunate,

because it would cause a further contraction

in activity from its post‐SD level.

1. Introduction

As social distancing (SD) comes to an end,

restoring economic activity will face a number

of challenges. This article uses the Keynesian

macroeconomic model in McDonald (2020) to

consider the impact of four effects caused by a

period of SD and discusses how fiscal policy

can aid recovery in the face of these effects.

The four effects of a period of SD

considered here are as follows.

1. Productive capacity will be reduced.

During a period of SD, some businesses

will not have operated at all and some only

at reduced rates of operation. This may

reduce the effective size of the capital

stock, and so require, when SD restrictions

are lifted, increased capital expenditures to

make good. For example, some new

businesses may be set up to replace non‐

operating businesses and some of these

new businesses will not be able, or will not

choose, to take over the capital stock of the

disappearing business but instead start

more‐or‐less from fresh. Furthermore, in

the post‐SD economy, some restrictions

may persist, requiring modifications to

existing capital, such as reorganising the

layout in some retail stores. The loss of

productive capacity may extend to the

industries producing capital goods.

2. Restarting businesses will be costly. There

will be costs of rehiring labour, re‐

establishing production and re‐establishing

* McDonald: The University of Melbourne, Melbourne,

Australia Corresponding author: McDonald, email

<i.mcdonald@unime lb.edu.au>

I thank Jeff Borland, Michael Keating and Daina

McDonald for helpful comments and suggestions.

© 2020 The University of Melbourne, Melbourne Institute: Applied Economic & Social Research,

Faculty of Business and Economics

Published by John Wiley & Sons Australia, Ltd