The Anxiety of Epidemics

Anxiety during an epidemic has micro and macroeconomic consequences. I capture such anxiety in a macroeconomic setting in which heterogeneous households are uncertainty averse toward both individual and aggregate health outcomes. Fear of individual infection increases precautionary savings and lowers the supply of labor by healthy households, while concern about the aggregate growth in infections raises the market price of risk and deters real investment. Since anxiety negatively correlates with wealth and health, its distortions are most severe for poor healthy households and limit fair redistribution through private insurance. The decline in real activity not only depresses capital and asset prices, it can also raise spot prices and wages through reduced competition.