A Counterfactual Economic Analysis of Covid-19 Using a Threshold Augmented Multi-Country Model

This paper develops a threshold-augmented dynamic multi-country model (TGVAR) to
quantify the macroeconomic effects of Covid-19. We show that there exist threshold effects
in the relationship between output growth and excess global volatility at individual country
levels in a significant majority of advanced economies and in the case of several emerging
markets. We then estimate a more general multi-country model augmented with these
threshold effects as well as long term interest rates, oil prices, exchange rates and equity
returns to perform counterfactual analyses. We distinguish common global factors from
trade-related spillovers and identify the Covid-19 shock using GDP growth forecast revisions
of the IMF in 2020Q1. We account for sample uncertainty by bootstrapping the multi-country
model estimated over four decades of quarterly observations. Our results show that the
Covid-19 pandemic will lead to a significant fall in world output that is most likely long-lasting,
with outcomes that are quite heterogenous across countries and regions. While the impact
on China and other emerging Asian economies are estimated to be less severe, the United
States, the United Kingdom, and several other advanced economies may experience
deeper and longer-lasting effects. Non-Asian emerging markets stand out for their
vulnerability. We show that no country is immune to the economic fallout of the pandemic
because of global interconnections as evidenced by the case of Sweden. We also find that
long-term interest rates could fall significantly below their recent lows in core advanced
economies, but this does not seem to be the case in emerging markets.