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Understanding Economic Instability during the Pandemic: A Factor Model Approach
Monica Billio, Roberto Casarin and Fausto Corradin
Abstract
This chapter studies the effects of the COVID-19 pandemic on the economic structure of the US and EU economies by measuring its impact on some reference macro-economic variables. We use a factor model approach on a set of variables available at different frequencies (daily, weekly, monthly, and quarterly) and provide evidence of instability in the primary factors driving the economy. A sequential analysis of the factors allows us to evaluate the model's forecasting performance and extract some instability measures based on the factor model's eigenvalues. Finally, we show how to use COVID-related variables, such as policy, economic, and health indicators, to compute conditional forecasts with factor models, and perform a scenario analysis on the variables of interest to understand economic instability.
Keywords: COVID-19; factor models; forecasting; scenario analysis; uncertainty; vector autoregressions
1 Introduction
Despite the relevance of the topic, the impact of COVID-19 on economic systems has been investigated in only a few papers. Much attention has been paid to possible recovery patterns and how they can be driven by more sustainable choices. The multiple positive effects of lockdowns on the environment and society, including biodiversity (Prakash & Verma, 2020) have been analysed, but as Ibn-Mohammed et al. (2020) argue, it is helpful to diagnose the danger of relying on pandemic-driven benefits to achieving sustainable development. Ibn-Mohammed et al. (2020) also emphasizes the need for a decisive, fundamental structural change to the dynamics of how we live. Also, in Battiston, Billio, and Monasterolo (2020), there are several analyses of the possible economic impacts of COVID-19 from different perspectives. Battiston et al. (2020) discuss how ‘business as usual’ recovery strategies may jeopardize mid-to-long-term sustainability and financial stability objectives. Strengthening socio-economic resilience against future pandemics (as well as other shocks) calls for recovery measures that are fully aligned with sustainability and climate change objectives and global corporate taxation policies; tackling these long-term objectives is not more costly than funding the current short-term measures.
Among the possible consequences of the pandemic, the shock to the labour market is certainly one of the most relevant, and it should be managed in a manner that does not leave a post-COVID-19 world more disastrous (Aberinpoka Awafo, Kwame Morgan, & Quartey, 2020). The impact of COVID-19 on event businesses is also relevant (Madray, 2020). The relationship between the COVID-19 pandemic and the financial markets has been investigated (Sansa, 2020) in the context of various factors, such as lockdown approaches, moratoriums, different impacts on banking, financial services, and the insurance sector (Ramasamy, 2020). The effect of the pandemic has already been examined in the context of Chinese economics (Liu, 2021), the short-term global economy (McKibbin & Roshen, 2021), and across industries and countries (Fernandes, 2020), and attempts have been made to investigate the possible mechanisms of economic contagion (McKibbin & Vines, 2020).
The purpose of this chapter is to study how the COVID-19 pandemic has changed economic structures, focusing on the US and EU economies. We aim to measure...
