Epidemics in the Neoclassical and New Keynesian Models
We analyze the effects of an epidemic in three standard macroeconomic models. We find that the neoclassical model does not rationalize the positive comovement of consumption and investment observed in recessions associated with an epidemic. Introducing monopolistic competition into the neoclassical model remedies this shortcoming even when prices are completely flexible. Finally, sticky prices lead to a larger recession but do not fundamentally alter the predictions of the monopolistic competition model.
We thank R. Anton Braun, Joao Guerreiro, Martín Harding, Laura Murphy, and Hannah Seidl for helpful comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.