Fiscal policy in the COVID-19 era

Vol: 
4/2022
Author name: 
Murphy, C
Year: 
2022
Month: 
April
Abstract: 

This paper analyses the COVID recession and the large fiscal policy response by modelling three scenarios using a macro-econometric model. Scenario comparisons show that the recession mainly arose from restrictions on certain consumer services to limit the spread of COVID-19. The large fiscal response to compensate for income losses in the restricted industries meant that unemployment was 2 to 3 percentage points lower for two years than otherwise would have been the case. However, there was over-compensation: for every $1 of income the private sector lost due to the restrictions, fiscal policy provided $2 of compensation. With the lifting of restrictions, the aftereffects of over-compensation are projected to generate excess demand driving inflation to a peak of 6 per cent. Also, three forms of over-compensation in the JobKeeper program that led the fiscal response had disincentive effects. The primary lesson for future pandemics is that fiscal policy should compensate, but not over-compensate, for income losses from health restrictions, both in aggregate and at the program level. The secondary lesson is that monetary policy needs to take more account of the stimulus already provided by the fiscal response, so that interest rates do not remain very low for too long.

Publication file: 

Updated:  29 March 2024/Responsible Officer:  Crawford Engagement/Page Contact:  CAP Web Team