With the retrospective investigations which were performed during early December 2019, COVID-19’s initial epiphany was noticed by a human with accompanying symptoms including fever, and cough as most prominently. Since COVID-19 has the property of being highly contagious, its impact isn’t limited to human health; what COVID-19 has brought can be identified where every human activity takes place, including the economy. According to the Principles of Economics written by N. Gregory Mankiw, the economy is a study of how society manages its scarce resources. The economy allocates resources through the decentralized decisions of many households and firms as they interact in markets of goods and services. Because COVID-19 is restricting human activity, the management and relocation of scarce resources aren’t being maximized to bring welfare to the society. There are two reasons why people’s activities are restricted: regulation and fear. Although this concept will be further analyzed in the following paragraphs, it’s crucial to be aware that these are the main factors that are causing the decrease in people’s aggregate demand and supply. These are the key concepts that will further demonstrate the reason for unemployment that countries around the world are trying to resolve, including the United States of America.
Unemployment can be divided into three types: frictional, structural, and cyclical. Frictional unemployment occurs when workers voluntarily become unemployed while searching for a better job or moving for unrelated reasons. Structural unemployment results from the change in the market system and when workers’ skills aren’t required anymore. Cyclical unemployment ensues when aggregate demand happens to be in a downturn. While it is true that the dwindling aggregate demand has an impact on the recent unemployment due to COVID-19, it is specified as quarantine unemployment because of the government regulation that restricted further social activities. Before making any further explanation, our team wants to make sure that although there might be some discrepancies between the real world and the economy, we focused more on approaching the economical concepts and theories.
<Analysis of the current situation>
The reason behind the rising unemployment
As the Covid-19 virus spread throughout the whole world, people were discouraged to actively engaging in economic activities, which shifts both the aggregate supply and aggregate demand curve to the left.
Aggregate demand decreased due to two main reasons. First, because Covid-19 is a highly contagious virus, the spread of the virus fosters fear among people. This morbid fear of Covid-19 strongly hinders people from going out and spending money. According to analytics platform 101 Data, YoY (year-on-year) consumer spending decreased by almost 40%. Furthermore, government regulation that prevents people from gathering, like social distancing, leads them to spend less money on leisure activities or outdoor entertainment. Thus, fear and government regulation affect overall consumption to decrease significantly and result in disproportionate income. Second, investment diminished along with consumption. Since the Covid-19 virus obstructs consumption, the firm anticipated future demand to decrease. This causes firms to put less money into future production. In other words, investment contracts, which is one of the Aggregate demand elements. As a result, consumption and investment caused the plummeting aggregate demand, thus the severe recession ensued.
Due to the unprecedented scale of the global shutdown, tons of people are temporarily or permanently dismissed. This is also a sort of unemployment, called “quarantined unemployment, named by Christina Romer, the economist from Berkeley. For example, if there’s no restaurant open, no amount of demand impetus will get people to go there. In spite of the increase in aggregate demand, which usually can be made by fiscal and monetary policy, without an increase in aggregate supply, the aggregate demand cannot be optimized and it will generate great ineffectuality.
The declining aggregate demand caused aggregate supply to decrease. Because the consumers are less willing to buy the goods, the demand for a firm’s production decreased. This became the reason for the aggregate supply and the demand for labor to abate, consequently increasing the number of cyclical unemployment. Unemployment reduces income and eventually restrains the purchasing power of consumers, and the result is the vicious circle of the rapid rise of the unemployment rate.
Effect of Unemployment
The effect of unemployment could be divided into two sectors, the individual living standard and overall national deficit. These effects are closely interwoven and affect each other while creating a vicious circle of increasing unemployment.
The most crucial effect of unemployment is the diminishing standard of living. According to the United States Census Bureau, the US population has increased over time, even after the COVID-19 pandemic initiated from 329.14 million in January 2020, to 329.73 million in June. This has to do with the positive externality of COVID-19 because the death caused by a bronchial illness such as pneumonia reduced along with the decreased amount of population using public transportation and vehicles. Furthermore, decreasing aggregate demand directly influenced the reduction of GDP. The conjunction of these consequences led to the GDP per capita dropping rapidly. The outcome is the weakening of the purchasing power of consumers and decreasing the standard of living. Also, the unexpected rise in unemployment could fuel the increase in the suicide rate and other social problems such as crime and vandalism.
One of the most outstanding consequences of a high unemployment rate is an increase in government deficit, which is equivalent to the nation’s overall deficit. Since the rising unemployment rate reduces the population eligible for tax payment, government taxation profit declines. As the government spends money to stimulate the economy (further explanation below), low tax revenue and high government spending enlarge the scale of the government deficit.
The Current Policy
The United States is currently focusing on increasing the aggregate demand in society. There are two major policies that the United States is utilizing, including the fiscal policy, and the monetary policy. According to the International Monetary Fund, the United States is continuing the Paycheck Protection Program by spending $321 billion on additionally forgiving loans from small businesses. The United States also spent $62 billion for the small business administration to provide subsidiaries and assistance. This program can be simultaneously classified as a fiscal and subsidy policy, with a significant amount of money spending made by the government. The Cares Act from fiscal policy provides tax rebates to individuals with $293 billion. This policy was enacted to increase government spending because it increases the aggregate demand, and therefore, it has a high tendency of serving as the foundation for the massive inflation derived from the excessive demand.
Within the monetary policy, the United States is dealing with open market operations as the federal government has planned to buy a large number of bonds including corporation bonds. Excessive purchase of corporate bonds lays the government at risk of losing money while the monetary policy indeed increases the money supply, Additional monetary policy was used by the US government to lower the reserve requirement for the banks, however, it turned out to have little effect on the society as banks tend to hold back money supplies in fear of losing it in a worldwide crisis.
The USA's federal fund interest rate decreased within the monetary policy, from 2.50 % in 2019 to 0.25% on March 15, 2020. This policy is intended to prevent the crowding-out, which is a phenomenon that occurs when government spending raises the interest rate and consequently reduces investment. Also, the monetary policy keeps the interest rate in low status and prevents the crowding-out effect.
Nevertheless, because of this low-interest rate, monetary policy became less efficient. From the perspective of the government, monetary policy’s main purpose is to decrease interest rates by increasing the money supply. However, as we’ve mentioned, the interest is near zero(0.25% on March 15, 2020) nowadays, which means monetary policy is not much effective in coping with the crisis.
In conclusion, although government spending will stimulate the economy and increase aggregate demand, using these policies has a drawback. Therefore, the US government should consider using auxiliary methods for supplemental support. We suggest that increasing aggregate supply is the key countermeasure to get rid of recession and effectively alleviate the high unemployment rate.
Writer: Michael Wu
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