Longer-run economic

consequences of pandemics
Covid-19 economics

Mihail ILIEV, Birkbeck College

28 May 2020
Main Question

• response of the real natural rate of interest to pandemic shock

• pandemics as randomised control trials

• study the average effect of pandemics across all major events since
the Black Death (14th centuries)

• looking at outcomes up to 40 years out

Natural rate of interest
equilibrium rate (R*)

• introduced (1898) by Knut Wicksell

• benchmark for monetary policy

• real short term interest rate in equilibrium

• associated with stable inflation (2%)

• the level of real returns on safe assets

• equilibrates savings supply and investment demand

• this variable may drift slowly for technological, political, or institutional reasons
Data

• historical interest rates from 1314 to 2018

• France (1387– 2018), Germany (1326–2018), Italy (1314– 2018), the Netherlands (1400–2018),
Spain (1400–1729, 1800–2018), the United Kingdom (1314–2018)

• underlying assets are debt contracts “which are not contracted short-term,
which are not paid in-kind”

• limited data on real wages for the United Kingdom from 1311 to 2016
Empirical Design
• model response of the natural rate to a pandemic:

• set of regressions to estimate

where They choose 10 lags

• model of the natural rate of interest as a latent unobserved variable:

Results
The European real natural rate of interest, displaying (1315–2018)

Real natural rate in Europe

Europe:

(France, Germany, the

Netherlands, Italy, Spain and
the United Kingdom)

Secular downward trend

• 10% in Medieval times

• 5% at start of Industrial
Revolution

• close to 0% nowadays

Medieval times: lots of

noise due to harvest, war,
etc.
Main Results
Response of real natural rate to pandemic
Following a pandemic the natural rate
declines for decades

Reaches nadir 20 years later

Natural rate bottoms at around 150 bcp

lower

More pronounced persistence than after

a financial crisis

Results
Country-specific responses

Striking heterogeneity

Explanations:

• relative exposure

• size of working
population

Pandemics:
contraction in labour
force and capital to
labour ratio

Results
Response of real wages

Mirror image of
response of natural rate
of interest

Effects felt over decades

Conforms with historical

facts:

Black Death led to

labour scarcity, higher
wages and lower return
on capital

Results
Pandemics vs wars

Omitted variable bias problem with

wars

Use indicator variable and estimate

an augmented local projection to
control for wars

Response to pandemics as before

and slightly amplified

Effects of war go the other way

Conclusions
• pandemics (since 14th century) have typically been associated with subsequent low
returns to assets

• these responses are huge

• smaller responses are found in real wages, but still statistically significant

• pandemics are associated with depressed investment opportunities for decades,

possibly due to excess capital per unit of surviving labour and/or heightened
desires to save

• if trends play out similarly, global economic trajectory will change significantly due
to Covid-19

• but low real interest rates will provide welcome fiscal space for governments to
mitigate the consequences
Conclusions
Caveat

Past pandemics occurred when virtually no members of society

survived old age

The Black Death and other plagues hit populations with the great mass
of the age pyramid below 60

This time may be different

Questions?