Question

Question: Assuming that a vaccine is discovered in say 18 months, discuss what might have happened to the LRAS curve over the period of the COVID crisis.

Although the virus has delayed the budget until October …. last week the secretary to the Treasury dropped some big hints on what to expect. In evidence to the Senate committee inquiring into the response to the virus, Dr Steven Kennedy started with the outlook for the labour market. The latest figures from the Australian Bureau of Statistics are for the four weeks up to mid-April. In round figures, they show that 900,000 people lost their jobs during the period (although 300,000 gained jobs), 1 million people worked fewer hours and three-quarters of a million kept their jobs but worked no hours (most of them protected by the JobKeeper wage subsidy scheme). So that’s a total of 2.7 million workers – about one worker in five - adversely affected by the snap recession. Total employment fell by 4.6 per cent, but total hours fell by twice that – 9.2 per cent, telling us much of the pain was borne by part-time workers. The rate of underemployment (mainly part-timers working fewer hours than they want to) leapt by almost 5 percentage points to 13.7 per cent. The “good” news is, Kennedy thinks that’s most of the collapse in employment we’re likely to see. We may get a bit more in the figures for May, and maybe even a fraction more in June. But that should be it. The trick, however, is that though the underlying position won’t be getting much worse, we’ll see the rate of unemployment shooting up. It had risen by “only” 1 percentage point to 6.2 per cent by mid-April, but Kennedy expects it to be closer to 10 per cent by mid-June. (And it would have gone a lot higher but for the JobKeeper scheme.) Such a strange outcome – it’s not actually getting much worse, but the unemployment rate is rocketing – is explained by the strange nature of this “coronacession”: a recession caused by the government, acting under doctors’ orders. 3 Econ1007 Macroeconomics Assignment SP5 2020 In an ordinary recession, almost all the people who lost their jobs in April would have immediately started looking for a new one, and so met the bureau’s tight definition of being unemployed. This time, most people didn’t start looking because many potential employers had been ordered to cease trading and, in any case, you and I had been ordered to stay in our homes and rarely come out. As the lockdown is eased, however, people will start actively looking for work, and the bureau will change their status from “not in the labour force” to unemployed, making the figures look a lot worse. On Wednesday, the bureau will publish the “national accounts”, showing what happened to real gross domestic product – the change in the economy’s production of goods and services – during the March quarter. [Note, GDP fell 0.3% in the March quarter- MS.] Kennedy is expecting real GDP to have fallen a bit, mainly because of the bushfires and the ban on entry to Australia by foreign tourists and overseas students. He’s expecting the big fall to come in the June quarter, and for the combined fall since December to be as much as 10 per cent. If it’s anything like that big it will be humongous. The total contraction in the last recession, in the early 1990s, was just 1.5 per cent. But, as with the job figures, Kennedy is expecting the contraction in GDP to end with the June quarter. The big question is, what happens after that? With most of the economy reopened – but, of course, our borders still closed to international travel – will most of us be back at work and producing and spending almost as normal? That is, will the period of the economy dropping like a stone be followed by it bouncing back like a rubber ball, producing a graph that looks like a big V? No. Kennedy told the Senate committee “I’m not predicting a V-shaped recovery in any sense, but the way we entered this [downturn], and the nature of this shock, give me some hope that if governments respond well, particularly through their fiscal levers [that is, their budgets], we needn’t have what’s called the L-shaped recovery”. That is, economic activity drops a long way, but stays there without growing. Kennedy says the L-shape is probably what people would think of as more like a depression. Kennedy noted that, according to separate figures from the bureau, the number of jobs in the accommodation and food sector fell by more than 25 per cent in just the three weeks to April 4, while jobs in the arts and recreation services sector fell by almost 19 per cent. He drew some hope from the fact that the sectors worst affected by the lockdown are “quite dynamic”. “They’re sectors that have high turnover in businesses coming and going, quite high turnover in employees and a lot of casuals,” he said. So, in the right conditions, they had the potential to re-establish quickly. In contrast, it was hard to re-establish a manufacturing plant quickly. In this strange recession, manufacturing, construction and mining had been allowed to continue without much disruption. If you rule out V-shaped and L-shaped recoveries, what’s left is a U-shape. You go down fast but bounce along the bottom before going back up. But our success in suppressing the virus means we’ve been able to start dismantling the lockdown earlier than the six months initially expected. “So in some ways we’re actually a little more optimistic [than we were] – maybe we just squeeze the U together a bit,” he said. That’s looking at our domestic economy. Looking at the prospects for the global economy, it’s possibly worse than he first thought. But even here Kennedy finds some source of hope. It so happens that our major trading partners – China, South Korea and Japan – are among the countries that have done better at beating the virus and getting back to work.

Answer 1

Led by a fall in demand conditions, the Long run aggregate supply curve will shift to the left as the economy will move on a lower trajectory of growth over the period of the Covid crisis. As the Real GDP will decline drastically as seen from the data with rising unemployment as domestic demand is constrained along with potentially limited global demand. Thus the overall level of LRAS will decline as there is limited demand in the economy, which will entail less production and people saving more and spending less.

As Aggregate demand has fallen, LRAS shifts to the left over the crisis as AD₀ shifts to AD₁.