The economic toll for the COVID-19 virus is very broad, hitting a range of sectors from airlines to universities to small businesses. The question on so many minds is how will the economic recovery unfold? Laura Veldkamp, Leon G. Cooperman Professor of Finance & Economics at Columbia Business School, conducted research that indicates the length of the recovery is closely tied to consumer and business confidence.
Veldkamp bases her conclusions on what is termed “belief scarring”. It is events that provoke persistent, negative changes in consumer confidence associated with the fate of the economy. These are historical moments she refers to as “tail events” and she asserts that events with the least precedent will have the greatest scarring impact on behavior. As result the coronavirus pandemic, that is often described as unseen before over generations will likely impact economic activity for years to come. The foundation of the economy made up of consumption, hiring, and investment is now scarred.
“The total cost of the COVID-19 pandemic is unknown and the worst could very well still be on the horizon,” says Professor Veldkamp. “Our research quantifies the scarring effect that this crisis has had on consumers’ beliefs and shows that while in any case the short-term economic impact of the pandemic is devastating, the long-term effects are much more worrisome. It’s not the size of the initial impact of the recession that matters, but the persistence of its scars that determine whether our recovery will progress or fall into a stalemate.”
She and her co-authors believe that timely interventions such as such as the $2-trillion CARES Act may make a significant difference in a recovery extending into the future. Without policy intervention, the long-run cost of belief scarring potentially adds up to 180% of annual output in the conservative estimate with 10 years of lost output in the worst case.
“We know that immediate economic interventions are expensive. But in the long-term, these kinds of interventions can be the difference between a progressive versus a sluggish recovery,” “Veldkamp said.
Therefore, it is very important to watch the psychology of consumers and businesses and align with policy decisions that intervene in the creation of any “belief scarring”.
The authors feel that ideally in the absence of belief scarring a recovery could be “quick and complete” despite a sizeable initial impact. But that is not the case, it is dependent upon how much scarring there will be.
The study can be found online: Scarring Body and Mind: The Long-Term Belief-Scarring Effects of COVID-19.
Professor Veldkamp’s study was published in the Centre for Economic Policy Research and co-written with Julian Kozlowski, Senior Economist in the Research Division of the Federal Reserve Bank of St. Louis, and Venky Venkateswaran, Associate Professor of Economics at New York University’s Stern School of Business.
