The Economic Impact of Pandemics: Real and Financial Transmission Channels

We explore the economic impact of the pandemic and the importance of real and financial sector linkages in this context. We explicitly model the financial sector and trace its role in propagating the pandemic shocks. We find that the pandemic-induced adverse labour supply shock can have sizable effects on the real economy, which are further propagated through the banking sector. Moreover, the contemporaneous pandemic-induced financial shock has financial, but also real effects, including high and protracted firm bankruptcies as well as a more fragile banking sector, thus hindering the financing of the real economy. The duration of the pandemic matters for its impact on the macroeconomy, as both business investment and bank balance sheets take disproportionately longer to recover. Our findings underline the need for well-targeted policy measures to support the real economy and, secondarily, the financial sector during the pandemic and provide justification for several of the policy initiatives recently taken by governments, central banks and regulatory institutions around the world.