Preparing for a pandemic - a theoretical perspective on the trade-offs of unconventional monetary policy

Sammanfattning: As the COVID-19 pandemic spread across the globe, unprecedented policy measures were implemented by central banks and governments to dampen the effect on the real economy. Alongside the spread of the pandemic, research regarding how to simulate similar effects of the virus on the real economy and how to formulate optimal policy began spreading at an equal pace. The aim of this thesis is twofold. It tries to contribute to this new strand of research by using a dynamic stochastic general equilibrium (DSGE) model with financial frictions to mimic the movements of key economic variables to how they moved during the outbreak of the COVID-19 pandemic. To simulate these outcomes, a time-preference shock to households’ discount factor is applied, as well as a total factor productivity shock and a shock to the external finance premium. The second aim of this thesis is to evaluate how the European Central Banks’ (ECB) previous unconventional monetary policy, in the form of funding-for-lending schemes, has impacted the resilience of the Euro Area economy when an adverse shock hit. The model-specific outcomes from this exercise indicate that the return to physical capital has been somewhat eroded following these unconventional measures from the ECB, thus making firms probability of default higher.