Question

1. Explain the impacts on consumption and investment after of the emergence COVID-19. In answering this question utilize the permanent income/life cycle hypothesis to make predictions about consumption and use Tobin’s-Q or the user cost of capital theory to make predictions about investment. Ensure any diagrams are correctly and clearly labelled.  
2. Explain the initial impact the emergence COVID-19 had on stock market prices. In answering this question focus on the role of expected future profits and expected future interest rates.   
3. Explain impacts on stock market prices, investment and output of monetary policy aimed to offset the short-term impacts of the COVID-19 shock. What happens when interest rates hit zero lower bound? Ensure any diagrams are correctly and clearly labelled.

Answer 1

Due to COVID-19, the consumption and investment got a major hit all over the world.

There were 3 main impact of COVID to deal with which government is struggling even today to normalise the situation.

1. Supply side shock

2. Demand side shock

3. Uncertainty

Due to Covid, the consumption got a hit because a lot of people have lost their jobs. Thus this decreased their demand and a demand side shock arises all over the world. This phenomenon can be explained with the help of permanent income hypothesis.

Permanent income hypothesis says that consumption is altered by permanent changes in income and not by the transitory or temporary change in income.

So, because the loss of employment result in permanent change in income, thus this result in fall in comption of the people.

About the supply side shock- due to world wide lockdown, the production and investment got a hit. Due to the lockdown investment fallen tremendously. This can be explained using Robin's Q hypothesis.

The Q ratio, also known as Tobin's Q, equals the market value of a company divided by its assets' replacement cost. At its most basic level, the Q Ratio expresses the relationship between market valuation and intrinsic value. In other words, it is a means of estimating whether a given business or market is overvalued or undervalued.

In lockdown, when the businesses are shut or are out of production, this reduces the market value of their assets and increases the replacement cost of the capital. Thus the value of Tobin" Q fall. Thus investment fall.

The emergence of Covid has also impacted the stock market. All the stocks were losing their value. The price or value of stocks depend on the expected future profits and interest rates.

After Covid emergence, the expectation was the fall in future profits, thus the stock prices of most of the stocks falled.

In order to offset these severe impact of COVID era on consumption, investment and stock prices, government has took many steps. Government have adopted easy monetary policy to increase the money supply and hence increase the demand. And also provide cheap loans to the investors in order to increase the investment.