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Impacts of a Potential Influenza Pandemic on New Zealand's Macroeconomy - PP 06/03

Assessing the Impact of a Pandemic in New Zealand

We concentrate on the direct impact of a pandemic and the recovery.

This evaluation of the impact on GDP concentrates on the second stage, the direct impact of a pandemic, and the third stage, the mid-term recovery. We assume the first stage anticipatory effects are either small or tend to be offsetting once the direct effects of the pandemic unwind. Our estimation of the direct impact is simple and does not include all the effects noted above. In our treatment of the recovery we assume no change in long-run labour productivity growth. We assume that the economy gradually converges to a long-run path with a lower population and therefore lower labour force (potential GDP in each future period being reduced by the assumed mortality rate of the pandemic).

We estimate the impact of a pandemic at a nationwide aggregate level. We do not consider effects on particular regions. We assume that the pandemic takes eight weeks and that it occurs in one wave of infection. The 1918 pandemic occurred in three waves, where the second wave was the most deadly. The economic impact of a multiple wave pandemic may be higher than a single wave pandemic because the disruption to normal life will occur over a much longer period. It is impossible to predict the number of waves a pandemic will have, so we have chosen one wave and in this sense our estimates may be conservative.

We also assume that during a pandemic normal social relations will continue (i.e. no riots and the continuance of normal law and order), and that infrastructure and utilities continue to operate. If any of these assumptions fail to hold the impact will be different and most likely more severe. It is also assumed there is no long term impact on the structure of the world and New Zealand economies. Another assumption we have made is that the pandemic occurs in New Zealand at approximately the same time as for the rest of the world. If it occurs significantly later in New Zealand, we could suffer from a period of disrupted trade and low confidence before the pandemic arrives. This would prolong the overall impact of a pandemic, but may allow time for the development of a vaccine that would lessen the cumulative impact.

As discussed above we estimate the reduction in GDP due to the pandemic in two stages, the direct impact during the pandemic and recovery from the direct impact. To estimate the direct impact we look at expected reductions in GDP due to three sources:

  • the lost output due to people being away from work;
  • the temporary reduction of output from industries due to reduced demand, or closure of businesses due to health reasons; and
  • the permanent reduction in potential GDP due to death.

The lost output due to people away from work is estimated from the sickness rates generated by the planning model developed by the Ministry of Health and assuming an additional absenteeism rate. To calculate the impact of workers being away for sickness and absenteeism reasons we assume that a 1% reduction in the labour supply leads to a 0.6% reduction in GDP. We assume the relationship between reduction in labour supply and output is less than one-to-one because capital is unaffected. Most of the labour supply reduction is temporary in nature and we assume there will be a compensating increase in labour productivity. This is very likely the case for small reductions in labour supply, but may not necessarily be the case for the large reductions this paper considers, and therefore our estimates may be conservative for a severe pandemic. We do not know in which season the pandemic might occur, and therefore ignore seasonal changes in GDP.

The economy wide reduction in output due to reduced demand or closure of industries is calculated by aggregating estimated reductions in output for each industry. Because it is unclear exactly how much demand will be reduced for each industry we investigate a number of different cases. For all our calculations we assume the measured output in the government sectors of the economy and in health and education does not change during the pandemic. The measured output of these sectors is primarily based on the level of funding, and this is unlikely to change during a pandemic despite likely decreases in actual output.

The lost output due to death is taken into account as a permanent reduction in the level of GDP, in the severe pandemic case a 0.8% reduction in the level of potential GDP. In our estimation of the initial shock to GDP we do not make an in-depth analysis of multiplier effects of reduced demand or supply in particular industries on the economy as a whole. Instead we look at a number of demand and closure impacts.

Note that some of the reduction in GDP due to demand side effects will already be accounted for in the supply side calculation. To avoid double counting we have at any time taken the reduction in GDP to be the maximum of either the supply side or demand side effect. This assumes that labour resources can be reallocated in industries so that supply reductions occur in the areas of reduced demand. In this sense this is a minimum estimate of the impact as reallocation may not be possible, especially for the short time scale of a pandemic.

Following the initial decline in GDP, the economy is expected to recover to the baseline level of GDP (minus the potential lost due to death). We assume the recovery follows a path generated by the New Zealand Treasury Model (NZTM) developed by Szeto (2002). NZTM is a computable general equilibrium model of the New Zealand economy. It is a three-good, small open economy model featuring a well developed production block that has been econometrically estimated. The model has a two-tiered structure: a steady state version of the model is used to estimate the equilibrium exchange rate and potential output, and a dynamic version of the model that traces the response of macroeconomic variables to various shocks. There are four behavioural sectors in NZTM: the private business sector, the household sector, the external sector and the government sector. The interaction between these sectors is fully described in Szeto (2002).

The main use of NZTM is to understand and forecast how the economy responds to shocks. In general, the economy would move along an equilibrium growth path in the absence of shocks, and shocks from both the demand and supply side of the economy will push the economy away from the equilibrium growth path. Even when a shock lasts for a short period, the impact of the shock on the economy can persist over a much longer period of time as there are a great deal of interdependencies within the economy, both across sectors and over time. The strength of NZTM is to provide a consistent framework to analyse how the economy returns to the equilibrium growth path after a shock as in Figure 1.

In order to generate a recovery path in NZTM for the economy after the initial pandemic impact, we impose temporary shocks on both the demand side and the supply side of the NZTM model to generate an initial reduction in GDP of the order of the initial reduction calculated from our initial impact calculation. This recovery path is then scaled for each different initial impact we consider.

It must be noted that the historical shocks used to calibrate NZTM are quite different to the severity and nature expected from an influenza pandemic. A pandemic shock is outside normal experience and the recovery path generated using NZTM may not therefore accurately represent the potential recovery path. We use NZTM’s recovery path only as a first approximation. Unfortunately there is little available research evaluating the impact and rate of recovery from pandemics to inform this work.[10]

One modification we do make to NZTM is the treatment of fiscal policy in the recovery stage. The fiscal rule in NZTM normally allows tax rates to adjust to ensure a public debt target is maintained. This would imply that, for a given government expenditure path, tax rates would have to rise during a pandemic to sustain the debt target. In the simulation shown in this paper, we relax the public debt target constraint and allow debt to increase. We have not adjusted NZTM’s monetary policy rule, which assumes the central bank adjusts short-term interest rates to achieve an inflation target of 2.0% per annum over the medium term.

Notes

  • [10]One exception is Brainerd and Siegler (2003).
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