Abstract

 
 
 
 This paper analyzes the economic impact of the COVID-19 pandemic on a small tourism dependent open economy. The lockdown affected both the demand side and the supply side of the economy, as production of goods and services dramatically dropped due to firms’ shutdowns, broken supply chains, or bankruptcies, and aggregate demand diminished due to lower consumer confidence and investment cutbacks, accompanied by a dramatic fall in international tourism demand, in particular due to travel restrictions. We look on these supply and demand changes through the lens of a macroeconomic model of a small open economy, comprising an industrial and a tourism sector. For this purpose, we modify Schubert’s (2013) model by introducing a multiple shock which reflects (i) reduced sectoral productivities due to, e.g., broken supply chains, (ii) a drop in employment due to firms’ lockdowns, and (iii) a sharp decline in international tourism demand. We find that the multiple shock leads to an immediate drop in GDP and a boost of the short-run unemployment rate, followed by a gradual transition back to steady state. The adverse effects on the tourism sector are the more severe the slower international tourism demand reverts to pre-crisis levels, but they do not strongly spill over to the industrial sector. Furthermore, even if international tourism demand recovers quickly, the effects on the industrial sector barely change. The length of the industrial sector’s recovery basically depends on the speed of restoring its sectoral productivity rather than on international tourism demand. The reason for this result can be found in the absorbing effect of the relative price of tourism services in terms of the industrial good.
 
 
 
Highlights
At the end of 2019, the SARS-CoV-2 virus (COVID-19) was discovered in Wuhan, China, where it spread off over the world
While the dynamics on the labor markets are driven by search and matching searching workers with open positions, we assume that sectoral productivities and the international tourism demand shift parameter gradually recover and will eventually return to their pre-shock levels
Starting from the benchmark equilibrium, we investigate the economic dynamics caused by the COVID pandemic
Summary
At the end of 2019, the SARS-CoV-2 virus (COVID-19) was discovered in Wuhan, China, where it spread off over the world. The COVID-19 pandemic caused a huge shock to the entire world, as it hit almost every country and its economy. While the dynamics on the labor markets are driven by search (unemployment) and matching searching workers with open positions (job offers posted by firms), we assume that sectoral productivities and the international tourism demand shift parameter gradually recover and will eventually return to their pre-shock levels. As the demand drop for domestically produced tourism services outweigh the reduction in domestic tourism service production by far, the price of tourism services falls on impact and follows a non-monotone path back to its pre-shock level Due to these price movements, domestic residents will change their consumption pattern.
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