Fiscal Policy in the COVID-19 Era

CAMA Working Paper 27/2022

50 Pages Posted: 30 Mar 2022

See all articles by Chris Murphy

Chris Murphy

Australian National University (ANU)

Date Written: March 28, 2022

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 the income losses in the restricted industries meant that unemployment was 2 to 3 percentage points lower in 2021-22 and 2022-23 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 economy recovered, but the aftereffects of over-compensation generate excess demand driving inflation to a forecast peak of about 6 per cent in 2022 and 2023. Overcompensation can also have disincentive effects, as seen in the three forms of overcompensation in the JobKeeper program that led the fiscal response. The primary lesson for future pandemics is that fiscal policy should compensate, but not overcompensate, 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.

Keywords: fiscal policy, COVID, econometric modelling, macroeconomic outlook, JobKeeper

JEL Classification: E37, E62, E63, H32, H68

Suggested Citation

Murphy, Chris, Fiscal Policy in the COVID-19 Era (March 28, 2022). CAMA Working Paper 27/2022, Available at SSRN: https://ssrn.com/abstract=4069085 or http://dx.doi.org/10.2139/ssrn.4069085

Chris Murphy (Contact Author)

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

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