The Cost of Coronavirus Uncertainty: The High Returns to Clear Policy Plans

• Author: Gabriel Züllig,Giovanni Pellegrino,Federico Ravenna
• DOI: http://doi.org/10.1111/1467-8462.12383
• Published date: 01 September 2020
• Date: 01 September 2020

The Australian Economic Review, vol. 53, no. 3, pp. 397–401 DOI: 10.1111/1467-8462.12383

The Cost of Coronavirus Uncertainty: The High Returns to Clear

Policy Plans

Giovanni Pellegrino, Federico Ravenna and Gabriel Züllig*

Abstract

Policymakers face an extremely uncertain

environment during COVID‐19. Using a non-

linear VAR estimate for the Euro Area, we

argue that the benefit of reducing policy

uncertainty at a time dominated by pessimistic

expectations amounts to several points of

GDP. The impact on the economy of un-

certainty shocks is much larger during

periods of negative outlook for the future.

We estimate the impact on industrial produc-

tion of the current COVID‐19 induced un-

certainty to peak at a year‐over‐year growth

loss of −15.4 per cent in September 2020, and

to lead to a fall in CPI inflation between 1 per

cent and 1.5 per cent. Policies providing

state‐contingent scenarios ready to be adopted if

the worst‐case outcomes materialise can reduce

theimpactofuncertainty.

1. Introduction

As countries plan a gradual reopening of the

economy after the COVID‐19‐induced lock-

down, survey measures of confidence are still

at their lowest, reflecting a pessimistic outlook

for the future. Global and US indices of

economic uncertainty reached an all‐time high

at the end of March 2020. By the end of May

the value of the US option‐implied stock‐

market uncertainty VIX index was still 200

per cent of its value at the end of 2019. In this

article we argue that the returns to enacting

policies reducing the uncertainty in the

economic outlook by providing to the public

contingent scenarios are very high—and they

are high exactly because the average outlook

is so bleak.

Business and consumers views about the

economic outlook as a result of the pandemic

follow two channels. First, pessimistic ex-

pectations lower spending and demand for

final, intermediate and investment goods and

services. Second, a sharp rise in economic

uncertainty—that is, an increase in the

dispersion or the range of possible future

economic outcomes—increases the risks in

the outlook. Estimating a nonlinear VAR for

the Euro Area, we find that at times of low

prospects for future economic activity, an

increase in the dispersion of future outcomes

has a much larger impact on the economy,

relative to normal times. Many more con-

sumers and firms, for example, may be closer

to a worst‐case scenario where they comple-

tely lose any income stream, and may

* Pellegrino: Aarhus University, Aarhus, Denmark;

Ravenna: Danmarks Nationalbank, University of

Copenhagen, HEC Montreal, CEPR; Züllig: Danmarks

Nationalbank, University of Copenhagen, Copenhagen,

Denmark. Corresponding author: Federico Ravenna,

email <fera@nationalbanken.dk>. The views expressed

in this article are those of the authors and do not

necessarily reflect the position of Danmarks

Nationalbank.

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

Faculty of Business and Economics

Published by John Wiley & Sons Australia, Ltd