Managing COVID Policy Uncertainty: A Behavioural Macroeconomic Model
- Publication Type:
- Poster
- Citation:
- 2022
- Issue Date:
- 2022-01-07
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The COVID pandemic has triggered un- precedented macroeconomic shocks. Large fiscal deficits, historically low interest rates and fluctuations in cash hoarding, alongside long-term trends away from fiat currency towards electronic transactions and crypto- currencies, have magnified policy uncertainty and loosened policy-makers’ control of the monetary transmission mechanism. On the real side, a complex nexus of demand- and supply-side shocks have catalysed the inflation- ary pressures now building around the world.
In analysing the macroeconomic policy impli- cations of these COVID trends, this research contrasts behavioural economic insights about present bias with rational expectations mod- els of time-inconsistent monetary policy and explores the implications for control of infla- tion. Preliminary theoretical analysis shows that policy uncertainty is magnified when policy-makers’ loss functions embed present bias in the form of quasi-hyperbolic discounting relative to a scenario in which policy-makers and private agents form forward-looking ratio- nal expectations using exponential discounting.
In identifying some of the empirical associa- tions, policy uncertainty data from Baker et al. (2020) (downloaded from policyuncertainty.com) is used in an econometric analysis of price pressures. These analyses suggest that policy uncertainty increases with the market volatility associated with the spread of infectious disease. The policy implications in the context of the ongoing COVID pandemic and its fallout are profound if the extent and complexity of policy uncertainty are magnified by policy-makers’ susceptibility to present bias, thus limiting their ability to control macroeconomic outcomes.
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