Prof E's Blog

~ 1250 words, ~7 min reading time

There’s been an interesting run of the media publishing articles about how great inflation is for ordinary people and how it hurts the rich. As an economist, these strike me as *VERY* weird articles. So, let’s flesh out the argument and what I think is wrong with it.

Basic argument: inflation is good for debtors, bad for creditors

This is correct, but leaves out some really important stuff. So, let’s consider 4 hypothetical people, and show how inflation affects them.

Person 1: Drowning in Credit Card Debt

This person is in very bad financial shape. Perhaps they lost their job during the pandemic, and could only find something paying much less, but didn’t manage to bring their expenses down. This person is renting, and has a credit card balance. They’re currently paying 12% interest on the credit card. They have, however, finally managed to achieve a “primary balance”, so, if it weren’t for credit card payments, they’d be just barely getting by. For these calculations, I’ll ignore that credit card interest compounds, so my estimates for credit card debt a year from now are a bit too low.

Before inflation:

Monthly income (after taxes): $2000
Monthly expenses: $2200
Credit Card Debt: $10,000 (this is growing by ~$300 per month, $100 from interest and $200 from additional charges)
Credit Card Debt 1 year from now: ~$13,600, about 6.8x monthly incom

Inflation happens: raising expenses (except credit card payment) by 6%, and wages by 4%. Interest rates on credit cards also rise to 15%. (Wages have been lagging behind inflation recently, and credit card interest rates have gone up.)

After inflation:

Monthly income (after taxes): $2080
Monthly expenses: $2320
Credit Card Debt: $10,000 (this is growing by ~$365 per month, thanks to a bigger gap between income and expenses and higher credit card interest charges)
Credit Card Debt 1 year from now: $14,380, about 6.9x monthly income

So, in comparison to income, the debt-laden person found their debts get *heavier*. This seems to contradict the basic argument. However, the basic argument assumes *fixed* interest rates (see: most mortgages and car loans in the US). With variable interest rates, interest rates will adjust to at least partially reflect the increased inflation rates.

Person 2: Living nearly paycheck-to-paycheck.

Here we have a person who is basically living paycheck to paycheck, but manages to save about 5% of their income in an emergency fund. Their income is the same as the previous person, but they don’t have the debt burden, and have a better balance between income and expenses – this may reflect that Person 1 was probably unexpectedly earning less than they were used to, while Person 2 has had time to adjust their life to their income. Like Person 1, this person is a renter – so all of their expenses are subject to inflation.

Before inflation:

Monthly income (after taxes): $2000
Monthly expenses: $1900
Accumulated savings: $1000 in a savings account earning 0 interest, saving $100 per month.
Current Savings = 53% of monthly expenses
(This was pretty close to “me in grad school before I got married” – though I did have some investments.)

Then, inflation strikes. Prices go up 6%, but wages go up 4%. (Recently, wages have been on the way up – but have been lagging behind inflation.)

After inflation:

Monthly income (after taxes): $2080
Monthly expenses: $2014
Accumulated savings: $1000 in a savings account earning 0 interest, saving $66 per month.
Current savings = 49.7% of monthly expenses

So, this person is *clearly* worse off. Their ability to save has been cut by 34%, and the value of their savings has been eaten into, making that emergency fund less of a cushion than it was before.

Person 3: Middle-class with Mortgage

Now, we have someone who earns a bit more, and is setting aside significant savings (20% of their income). But, like most people in the middle class, their main asset is their house. Their income comes from wages or salaries.

Before inflation:

Monthly income (after taxes): $5000
Monthly house payment: $1000
Monthly other expenses: $3000
Monthly expenses (total): $4000
Saving: $1000/month (20% of income)

Assets:
House: $150,000
Savings Acct: $20,000
Stocks: $100,000
Total: $270,000 – 67.5 months of expenses

(Note: I’m ignoring the mortgage itself here, since its value is fixed. Also, if that house value looks low – remember, I live in NE Ohio. Houses aren’t nearly as expensive here as most places.)

Inflation happens – 6% increase in “other expenses”, 4% in pay. House prices follow inflation rates, and stocks do better than that, earning 20% (approximately correct for this year).

After inflation:

Monthly income (after taxes): $5200
Monthly house payment: $1000
Monthly other expenses: $3180
Monthly expenses (total): $4180
Saving: $1020/month (19.6% of income)

Assets:
House: $159,000
Savings Acct: $20,000
Stocks: $120,000
Total: $299,000 – 71.5 months of expenses

Here, the result is a bit less clear – in terms of assets, the person is clearly better off, judging by months of expenses covered by the assets – because stocks did so well. However, saving has become slightly more difficult. But, thanks to the mortgage payment being fixed, they can at least save more in dollar terms than before, unlike Person 2 who didn’t have the benefit of any of their expenses being fixed.

Person 4: An Independently Wealthy Person

Here, I’m imagining an independently wealthy person. They have a bunch of assets that they can live off of – so they don’t have any “earned” income. Let’s say that it breaks down roughly like the overall holding of assets for US households as a whole. (This might seem like a weird assumption – but we have quite a bit of wealth inequality, so it’s not *way* off to do things this way.) 30% is in nonfinancial assets that will follow the inflation rate (6%). 15% in cash and bonds with fixed values, and 55% in stocks and business equity that outperforms inflation (20%). I’m going to arbitrarily say that they have assets = 100 months of expenses to start out, and that all expenses are affected by inflation.

Before inflation:

Monthly expenses: $100,000

Assets:
Nonfinancial Assets: $3,000,000
Cash/Bonds: $1,500,000
Stocks/Equity: $5,500,000
Total: $10,000,000 – 100 months of expenses

After inflation:

Monthly expenses: $106,000

Assets:
Nonfinancial Assets: $3,180,000
Cash/Bonds: $1,500,000
Stocks/Equity: $6,600,000
Total: $11,280,000 – 106 months of expenses

So, this person is certainly made better off, though, measuring *just* from how much assets/expenses increased in % terms, the middle-class person with a mortgage benefited slightly more (about a 7% increase v. a 6% increase), thanks to the fixed part of their expenses.

Conclusions

While I developed all of these examples in good faith, we shouldn’t take them *overly* seriously. For example, while I do think that, in general, the wealthy gain from inflation while the poor lose, these illustrations were intended instead to make a few points:

(1) People with fixed expenses gain from inflation. In our example, that was just the middle-class with a mortgage. Everyone else was made worse off, or, in the case of the wealthy, had their gains offset, because of inflation hitting expenses harder than wages. (Aside: Robert Kiyosaki has suggested that really poor people don’t have debt, since they can’t qualify for it. I think this isn’t actually true now – instead, the truth is that poor people have *particularly bad*, variable payment debt.) It’s not as simple as “debtors gain”, since some debts have variable interest rates which tend to rise in inflationary environments. So, the *type* of debt matters.

(2) People with assets with variable values can gain from inflation. In this case, that was “stocks” – which benefited the wealthy and middle class particularly.

It is true that, for any particular fixed payment debt, the person who is paying it is made better off if inflation happens, and the person receiving the payment is made worse off. But, we shouldn’t be too quick to assume that the debtor is poor or the creditor rich.

~2400 words, ~10 min reading time

So, today, I finished a 9 year project – I read all three volumes of Marx’s Capital. (And no, I don’t want to hear about “Volume 4”. Using the most motivated of reasoning, I choose to believe that Marx’s “Theories of Surplus Value” in a separate work entirely.)

Below are my thoughts, presented not particularly systematically.

The Good

First, let’s be clear: I like free markets. I probably like capitalism, depending what you mean by the term. I’m also a professional economist trained in the Austrian and neoclassical (largely Chicago) approaches. So, much as Marx spent Capital critiquing capitalism, I will probably spend most of my entry here critiquing Marx’s Capital. But, there are some positives worth mentioning.

(1) Marx was very thorough. That’s why this work is 3 volumes long. In these volumes he incorporates a number of numerical examples, quotations from proceedings at Parliamentary sessions, some data, and naturally a great deal of his own theorizing.

(2) Given that he was writing slightly before the Marginalist Revolution really caught on (Marx wrote Capital from 1867-1883, while Menger’s Principles came out in 1871, so I can’t completely blame Marx for not fully incorporating marginalist insights), he has a surprising number of “almost marginalist” observations. The theory of ground-rent that he details – built largely on Ricardo, admittedly – has some nearly marginalist elements.

(3) Marx has an almost modern conception of “long run” v “short run” (though his terminology doesn’t match modern terminology), which I found interesting.

(4) In Capital, Marx is far more fair than I expected. He clearly is focused on taking a scientific approach.

(5) Marx observes that “surplus labor” (that is, doing work that goes beyond what is necessary for the worker to survive) is a feature common to all societies. The explanation: not everyone works, so workers have to work more to make up for the fact that infants and the elderly can’t. In addition, because of uncertainty, people plan to produce a bit more than necessary as a form of insurance against bad outcomes. I thought this was an interesting observation.

The Bad

(1) I originally set out to read Marx to find out where he went wrong, exactly. The answer: Volume 1, Page 4. It was at that point that Marx points out that if two things are exchanged for each other, they must be equal. While it’s weird to say that $5 is “equal to” a skein of woolen yarn, it must be true for both the buyer and seller to engage in the exchange. This leads to the question: what, exactly, is equal between them? Marx suggests that it’s the labor that is embodied in them. After all, it can’t be the wool – since wool isn’t in $5 (at least, I don’t think it is…). But, the common factor in each is that each requires some amount of labor to produce. So, the value must come from labor. More on this in the next bad point.

(2) Marx’s writing is very hard to follow. Some of it is that terminology has changed, so when Marx says “price of production” and means “cost of production” it’s just confusing. But, some of it is that Marx has a tendency to use somewhat mystical language (if memory serves, he inherits this from Hegel – though it has been over 20 years since I’ve read Hegel). Since the last two volumes were published posthumously, Engels had to put some notes in them, and included his own clarification on a couple points in the edition that I have. This made it clear: Engels was a much better writer than Marx. Consider for example, the argument for the labor theory of value. Marx leaves the explanation almost mystical, and uses weirdly metaphysical language around it. Engels makes the point much more concrete. To understand the labor theory of value, you have to go back to a primitive barter economy. Engels observes that in such an economy, most people produce things for themselves, but end up with certain imbalances – like I had a weirdly good radish harvest, but my cow hasn’t been producing very well – and these imbalances create opportunities for trade. But, because I produce both radishes and milk myself, I know how much work it takes to make them, so I’m not going to trade more than one hour’s work worth of radishes for an hour’s work worth of milk. Nor will the person providing me with milk accept less than one hour’s worth of work of radishes in exchange for milk that took them an hour to procure. When stated this way, the argument, while still incorrect, is at least CLEAR. But, we have Engels, not Marx, to thank for that explanation.

(3) So, let’s tackle the labor theory of value as explained by Engels. The primary problem here is that it ignores the variation in people’s abilities. Interestingly, I use EXACTLY this kind of argument to illustrate terms of trade when we’re discussing comparative advantage and exchange in Principles of Microeconomics. But, one of the fundamental premises is that what I can produce with an hour of work is NOT the same as what you can produce with an hour of work. Therefore, it well may be that I’m willing to trade an hour’s worth of radishes for less than an hour’s worth of milk – because what took you 45 minutes would have taken me more than an hour. (Or, maybe, I just don’t have a cow… Though Engels allows for that possibility). Fundamentally, exchange arises from differences in our preferences and differences in our ability to produce – which then means that there is no clear amount of labor that is embodied in any particular item. Marx acknowledges that not everyone is equally productive, and so suggests that the value comes from the amount of “socially necessary” labor to produce something, but I was never quite clear what the phrase “socially necessary” means.

(4) Now, let’s get to the idea of surplus value. One thing I’ll give Marx – Marx is very devoted to the idea of having a grand unifying principle that ties everything together. His price theory is a great example of this. Exchange indicates that two goods have the same amount of “socially necessary labor” embodied in them. If one of those goods is money, that doesn’t change a thing. Money’s exchange value is based on how much labor went into producing the gold. It also applies to wages. The value of wages is the amount of product that it takes to get that labor produced. It’s the classical “iron law of wages”. This means that a worker will be paid an amount that allows them to subsist, but nothing beyond that. However, in the capitalist system, the means of production – that is, tools and the like – are owned by the capitalist. So, capitalists hire workers and make them work for 12 hours a day, even though they can produce enough to feed themselves in just, say, 6 hours. They are paid for the first 6 hours, but not for the last 6. (Of course, the way this works, in practice, is that they are paid enough to survive DAILY, and that amount is divided by 12 to get the hourly wage.) The first 6 hours are the “necessary” labor. The last 6 hours are the “surplus labor”. And this surplus labor is claimed by the capitalist in exchange for allowing the laborer to use the capitalist’s tools and the like. On the surface, this feels like it’s actually kind of accurate, right? The problem, of course, is that it ignores competition between capitalists for labor. So, even if it is true in a capitalist system that the workers are denied ownership of the means of production, the fact is that the capitalist class will tend to fight over the laborers that produce value – especially if economies of scale are as significant as Marx suggests. (He seems to believe that economies of scale are basically pervasive.) This provides some bargaining power which would allow workers to claim some of the surplus value for themselves. Now, naturally, workers are also competing with each other for jobs – so it’s not so obvious how this all will play out – but it seems far more reasonable to say that the wage will be somewhere between a subsistence wage and the full product of labor, rather than to just claim that it must be at the bottom of this range.

(5) Marx’s view of capital markets is really cool, but ends up undermining his claims about the power of the capitalist class. Suppose that the means of production are all owned by a single capitalist. In this case, holding wages down to subsistence seems very possible. Unless, that is, there is some way for the laborers to acquire some of their own means of production. A lot of Marx’s work assumes this is impossible. After all, if you’re paid a subsistence wage, what are you going to use to acquire the means of production? You’re literally spending your entire income on just barely getting by. It turns out that Marx HIMSELF provides the answer. In his section on credit, he explains how people can join the capitalist class by using credit to acquire the monetary capital they need to start a business (that is, acquire the means of production and hire workers). Practically, then, this means that the capitalist at least has to pay workers enough that they wouldn’t be better off borrowing from creditors to acquire their own means of production to use. But, won’t high interest rates prevent this? Well, no, according to Marx’s framework. Marx uses a profit theory of interest, in which the rate of profit on ownership of capital provides the maximum rate of interest that could be charged. So, borrowing to buy means of production means you will at least break even as long as your productivity level isn’t horrifically bad. As a simple example, suppose that, when you work for a capitalist, they make you work 12 hours a day, during which time you produce $50 of product, and then they pay you $25 for the day. You’ve been exploited out of $25 of your product. Now, let’s say that you could acquire the means of production for $100, but that you’d have to pay $10 per day in interest. The question you face: can you produce at least $35 of product in 12 hours with those tools? If the answer is yes, then you can break free of the capitalist system, if you so choose. If the answer is no, it must be that the capitalist isn’t just providing the means of production – instead, they are providing an organizational framework that allows you to produce an additional $15 if you work for them vs if you worked on your own. Put another way: the capitalist is actually productive. Whether Marx acknowledges this is not clear to me – there are some parts where he acknowledges the productivity of the capitalist system. Yet, he still holds that profit is exploitation of labor, rather than compensation for productivity gains.

(6) Another element that Marx misses is time preference, despite the fact that it’s baked into his explanations at places. He describes how capitalists must first put out their capital to acquire the means of production and pay laborers, and only later sell the product. Yet, he seems to miss that part of the reason that workers don’t do what I said above and take out loans to acquire the means of production themselves is that workers want to be paid now rather than later. That is, by paying wages before the sale of the product, capitalists are providing a service to the worker, and profit is, in part, a compensation for that service. Now, I can’t blame him too much for this – time preference was not very well understood yet, but that is an important point for the modern reader to remember.

(7) Marx’s discussion of the crises of capitalism was very hand-wavy. I was probably most disappointed in this, as Marx is so famous for his explanation of how the capitalist system would undergo periodic crises. However, either I just didn’t understand his argument, or there wasn’t much of one there. He does describe how the process of accumulation leads to a decrease in the rate of profit. I don’t find this claim particularly objectionable, to be honest, though I’d explain it differently than Marx does. But, it’s not at all clear why the profit ever has to turn negative so that a crisis would result. Can’t it just approach zero asymptotically? I couldn’t find an answer.

(8) Marx makes the assumption that capitalism is built on the desire for continuous accumulation. I don’t think this is necessarily true (though maybe this is just part of Marx’s definition – I honestly don’t know if he ever bothered to actually define what capitalism means). While there certainly are some individuals that act this way, there are also heirs of billionaires that, like the prodigal son, just blow their inheritances on wild living. You see the same thing with some first generation millionaires as well (celebrities can be prone to this). In short: the idea that financial capital will first be used to reproduce itself, and only secondarily be used to maintain the lifestyle of the capitalist requires further proof.

Concluding Remarks

I’d say that I’m glad I finished reading it rather than giving up entirely. However, I don’t think I’d recommend it. As I’ve said elsewhere, a great deal of Capital is simply boring. Before his own explanatory notes at the end of Volume 3, Engels says that he saw it as his job to try to publish what Marx wrote without making himself a coauthor by aggressive editing. In the end, I’m a bit sad about that. There was so much chaff in the work, that I very much feel like I missed some major threads while I was bogged down in numerical examples that added little and reading basically mystical explanations about how capitalists are just “personified capital”.

I strongly suspect that a better way to get at Marx’s thought is probably to read a more modern Marxist – someone like Richard Wolff – where the language won’t be as archaic, or to find a well-abridged version. Of course, it all depends on what your goal is. Following the modern/abridged path probably provides fewer bragging rights, but also probably helps you understand modern devotees far better than reading the original.

~ 800 words, ~4 min reading time

The $15 minimum wage is back in the news, thanks to Pres. Biden’s support for this wage. So, let me get some thoughts down on this.

1. Too many people rely on Card & Krueger’s Study

Pretty much any time you see a minimum wage advocate talk about the minimum wage, they’ll bring up Card and Krueger’s 2000 study. In brief: this pair of economists studied the data from fast food restaurants in NJ and PA when there was a minimum wage increase in one of the states, and found no significant employment effects. What effects they found seemed, on average, more positive than negative.

However, Card and Krueger are not the ONLY study about the minimum wage. There are loads – so it is only fair to look at what we term a “meta analysis”. These studies compile the results of other empirical studies. It’s a way of putting any one study in a broader context so that you can make more general statements about results. There are several meta analyses of the minimum wage out there. Here’s one clearly opposed to minimum wage increases and another which is much more favorable to them. Interestingly, the actual statistics aren’t that different between the two. So, this is a better place to look.

2. The data shows “significant, but modest” negative employment effects

The consensus seems to be that MOST minimum wage studies find negative effects on employment, but these effects aren’t very big. Something near a 0.05% drop in employment among low-wage workers for a 1% increase in the minimum wage seems to be about average. So, is this “significant”?

On the “yes” side we have those that like the language of “statistically significant”. What this means: the 0.05 result has a small enough margin of error that we are pretty confident it’s REAL. That is, the effect isn’t actually 0, but happened to look negative as a statistical anomaly. Instead, there is a real negative impact.

On the “no” side we have those that like the language of “economically significant”. What this means: 0.05 isn’t very big. Is this true? Well…

3. Even with a “modest” negative effect, a $15 minimum wage may lead millions of people to have problems with employment.

There are estimates that about 40% of the US workforce earns under $15 an hour. That’s about 64 million people. If each 1% increase in the minimum wage disemploys 0.05% of the impacted workers, then a move from $7.25 an hour to $15 an hour would lead to a drop in employment of about 5%. (I’m rounding a bit here.) That’s 3.2 million people.

Is 3.2 million people “a lot”? For perspective: there are currently about 11 million unemployed workers in the US, by the BLS’s definition. (For the BLS being “unemployed” means you “have no job, but are actively seeking employment” – it has no definitional connection to whether you’re getting unemployment compensation or not.)

I’ll let you decide if adding 3.2 million to a group of 11 million is “a lot”.

Naturally, this is a very rough “back of the envelope” calculation, and might be biased upward a bit – after all, the minimum wage of Washington state is already slated to go to $15/hour, so a federal minimum wage of $15/hr, slowly phased in is unlikely to have much effect there. The CBO’s estimates are that we’d see something close to a loss of 1.3 million jobs, though 3.7 million is a possibility on the high end. So, my back of the envelope calculation is close to the CBO’s worst case scenario.

4. There are better options.

While economists disagree on a lot, I think it’s fair to say that most economists would say that the way to help poor people is to give them money.

For example: economists generally agree that the Earned Income Tax Credit is a pretty efficient way to help those with low incomes, while even most of those that support a minimum wage increase don’t see it as very efficient.

I think it’s fair to say there isn’t a lot of consensus among economists on exactly what should be done about poverty – it’s a complicated issue, and the solutions depend very much on the multitude of causes – but the simple fact that even most of those that support a minimum wage increase don’t think it is very efficient is important. There are better ways.

A couple that might be worth thinking about: a Universal Basic Income or a Job Guarantee. Neither of these is “perfect”. However, they both offer options that could improve the well-being of those with low incomes without the small-but-real negative effects on employment that minimum wages have. They also have the benefit of putting the burden on the taxpayers rather than on employers. But, I confess I have developed a strong aversion to unfunded regulations.

~1100 words, ~6 min reading time.

I’ve been reading and thinking about The Macroeconomics of Epidemics by Eichenbaum, Rebelo, and Trabandt. Here’s my summary:

Model

The paper takes the basic SIR model and adds to it a macroeconomic component. The SIR model is a standard way of modeling the spread of an epidemic. In brief: the number of new infections is affected by the number of people who are susceptible to the illness (have no immunity), and the number who are infected. This paper adds a number of economic models to it. See below:

SIR model – the transmission is independent of economic behavior, but the economy is impacted by transmission. Specifically, if people are sick, they’re less productive. If they die, they will never produce again (obviously).

SIR-Macro model (“Baseline”) – transmission from three channels: shopping (proportionate to amount spent by susceptible and infected populations), working (proportionate to hours worked by susceptible and infected populations), and community (same as SIR model). People are aware of how their behavior affects their probability of infection, and take that into account when deciding to work or shop.

Medical Preparedness model – like Baseline, but the mortality rate is impacted by the # infected. This captures the idea of hitting the health care system’s capacity.

Treatment & Vaccine models – these models are like Baseline, but incorporate the expectation that a treatment (which is usable on the infected, and ensures recovery) or vaccine (which is used on the susceptible to ensure they never become infected) will be discovered.

Policy Instrument

All but the straight SIR model includes some kind of policy response. The paper models this as a tax on consumption – which would reduce consumption spending and work. Obviously, that’s not what we’re actually doing – but we can use this as an analogy by looking at the results on GDP from the real policies being enacted and the hypothetical consumption tax.

The paper involves a search for “optimal policy” – that is, policy that maximizes utility for the population. This isn’t just “don’t do anything” because, while people account for how their economic activity affects their own risk of infection, they DON’T account for how their activity affects the risk of infection for others.

Results

SIR Model – In the straight SIR model, 8% become infected at the peak, and 70% are eventually infected, and ~0.7% of the population die. There is also a mild recession – about a 2% drop from trend at the trough, and long-lasting economic effects because of those that died.

SIR Macro Model (baseline) – compared to the SIR model, there is a smaller, later peak (only about 5% at peak), and only about 50% of the population are ever affected. So, only about ~0.5% die. In brief: people being aware that they’re more likely to be infected if they go to work or go shopping will encourage people not to, so infections spread more slowly. But, we also get a much larger recession (9% drop in consumption at trough), and it lasts about 3 months longer. In this model, the optimal policy (based on a utility-based CBA approach) would be to increase restriction measures keeping pace with infection, and slowly back off as the % infected dwindles. Doing this would decrease the peak % infected to 2%, and would decrease total infected to about 35% – with 0.35% of the population dying. On the other hand, this leads to a deep recession – about 20% off trend at the trough and it takes about 3 years instead of a year and a half to get back to normal.

Medical preparedness – compared to Baseline, there is a smaller % infected (only about 3%), though there are more deaths (over 1% of population). So, a relevant health care capacity constraint leads people to be more cautious – decreasing infection rates – but not enough to totally offset the higher mortality rates. Because of this, the recession is very deep (- 20% drop in consmption at the trough). An optimal policy involves measures that aren’t much stronger than in the Baseline optimal policy scenario, but come much earlier, and are removed much more slowly. Interestingly, the optimal policy’s effect on the economy is to lengthen, but not deepen the recession. The trough is about the same depth – but the recession starts sooner (because of faster containment policies), and lasts longer – all because of the approach to containment.

Model with treatments – compared to Baseline, a model with treatments expected with a 2% probability each week (but that doesn’t actually materialize) shows almost no change.

Model with vaccines – compared to Baseline, a model with vaccines expected with a 2% probability each week DOES change the optimal policy significantly. Policy should kick in immediately – though not be quite as severe as in the baseline case, and slowly back off over the next 18 months, as the proportion of those with acquired immunity increases. (Policy doesn’t have to be as severe because of the possibility of a vaccine – so policy doesn’t have to do all of the heavy lifting with saving lives.) Interestingly, you end up with deaths with optimal policy here than in the baseline, unless a vaccine actually arrives. (Not that surprising – less severe policy means fewer lives saved by policy. If vaccines don’t cover the difference, then more people die.) The result of optimal policy is a faster, deeper, and longer recession than in the absence of policy – though the recession isn’t as severe as when optimal policy is applied to the baseline case.

Thoughts and Takeaways

First, I have some doubts about the basic economic model. Specifically, they don’t have capital in the model, so they’re probably overstating our ability to get back on track when policy is relaxed. I suspect that adding capital to the model would mute the optimal policy responses somewhat. Also, I’d not pay too much attention to the specific numbers – the calibration is naturally a bit tentative.

The choice of a consumption tax struck me as weird at first, but isn’t too bad, given that we’re stuck with this baseline model.

Takeaways:

(1) In every single case, there is a tradeoff between saving lives and saving the economy. However, their model doesn’t account for creative solutions that might be able to decrease transmission without creating significant economic costs on basically everyone. (Example: replacing general social distancing with more focused isolation for those infected or at high risk of it. Practically, we can’t do this in the US right now because we don’t have the testing capacity required.)

(2) In every case, there is some argument for a policy response – but this is only true because people don’t take into account their affect on others’ risk of becoming infected. In as far as people took this into account, then fewer restrictive measures would be justified in the model.

(3) An early, seemingly disproportionate response is justified if (A) we’re worried about the health care system’s capacity increasing mortality, or (B) we’re holding out for a vaccine – but even then, we should start to loosen up as people acquire immunity via the infection/recovery channel.