Research Database

From introduction: This paper is intended to introduce economists to a simple SIR model of the progression of COVID-19 to aid understanding of how such a model might be incorporated into more standard macroeconomic models. An SIR model is a Markov model of the spread of an epidemic in which the total population is divided into categories of being susceptible to the disease (S); actively infected with the disease (I); and resistant (R), meaning those that have recovered, died from the disease, or have been vaccinated. The initial distribution of the population across these states and the transition rates at which agents move between these three states determine how an epidemic plays out over time. These transition rates are determined by characteristics of the underlying disease and by the extent of mitigation and social distancing measures. This model allows for quantitative statements regarding the tradeoff between the severity and timing of suppression of the disease through social distancing and the progression of the disease in the population.

This paper shows that some key stylized facts of exchange-rate-based stabilization plans can be explained by the uncertain duration of the plans themselves. Uncertain duration is modeled to reflect evidence showing that devaluation probabilities are higher when the plans are introduced and abandoned than in the period in between. If contingent-claims markets are incomplete, this uncertain duration distortion introduces temporary fiscal cuts with large wealth effects. Investment and employment are also distorted, and the resulting supply-side effects play a critical role. Stabilizations of uncertain duration entail large welfare costs, but they are preferred to persistent high inflation. México’s experience is examined in the light of these predictions.

We determine the second best rule for the inflation tax in monetary general equilibrium models where money is dominated in rate of return. The results in the literature are ambiguous and inconsistent across different monetary environments. We compare the derived optimal inflation tax solutions across the different environments and find that Friedman’s policy recommendation of a zero nominal interest rate is the right one.