Epidemics in the Neoclassical and New Keynesian Models∗† Martin S. Eichenbaum‡ Sergio Rebelo§ Mathias Trabandt¶ June 19, 2020 Abstract We analyze the e§ects of an epidemic in three standard macroeconomic models. We find that the neoclassical model does not rationalize the positive comovement of consumption and investment observed in recessions associated with an epidemic. Intro- ducing monopolistic competition into the neoclassical model remedies this shortcoming even when prices are completely flexible. Finally, sticky prices lead to a larger recession but do not fundamentally alter the predictions of the monopolistic competition model. JEL Classification: E1, I1, H0 Keywords: Epidemic, comovement, investment, recession. ∗We thank R. Anton Braun, Joao Guerreiro, Martín Harding, Laura Murphy, and Hannah Seidl for helpful comments. †Matlab/Dynare replication codes will be made available by the end of June 2020 at the following URL: https://sites.google.com/site/mathiastrabandt/home/research ‡Northwestern University and NBER. Address: Northwestern University, Department of Economics, 2211 Campus Dr, Evanston, IL 60208. USA. E-mail:
[email protected]. §Northwestern University, NBER, and CEPR. Address: Northwestern University, Kellogg School of Man- agement, 2211 Campus Dr, Evanston, IL 60208. USA. E-mail:
[email protected]. ¶Freie Universität Berlin, School of Business and Economics, Chair of Macroeconomics. Address: Boltz- mannstrasse 20, 14195 Berlin, Germany, German Institute for Economic Research (DIW) and Halle Institute for Economic Research (IWH), E-mail:
[email protected]. 1Introduction Acentralfeatureofrecessionsisthepositivecomovementbetweenoutput,hoursworked, consumption, and investment. In this respect, the COVID-19 recession is not unique. At least since Barro and King (1984), it has been recognized that, absent aggregate productivity shocks, it is di¢cult for many models to generate comovement in macroeconomic aggregates.