## The COVID-19 Crisis and Low-Income Developing Countries: Impact, Policy Response and Policy Tradeoffs

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**Canonical URL:** [The COVID-19 Crisis and Low-Income Developing Countries: Impact, Policy Response and Policy Tradeoffs](https://www.imf.org/-/media/files/topics/lics/macro-research-for-development/newsletters/sep2020.pdf)

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### COVID-19 impact and policy guidance for Low-Income Developing Countries (LIDCs)
- LIDCs account for one-fifth of the world population and for only about 4½ percent of global GDP.
- LIDCs have suffered an unprecedented external shock from COVID-19 and face limited resources and policy instruments to combat the fallout.
- Policy recommendation from the IMF staff Board presentation (July 22):
  - Front-load containment measures to flatten the infection curve as much as possible and use the time to build up health sector capacity.
  - Move to more targeted measures when broad containment can no longer be sustained.
- Observation: LIDCs have broadly followed the front-loading then targeting script.
- Outcome: The presentation was appreciated by IMF Executive Directors; some requested frequent briefs. A blog inspired by the presentation has been published.

### WELL SPENT: How Strong Infrastructure Governance Can End Waste in Public Investment (IMF book)
- Book contains fifteen (15) chapters; 2 chapters benefited from IMF-FCDO macroeconomic research program support.
- Chapter 6 — "Public Investment over the Fiscal Cycle" (Tannous Kass-Hanna, Kangni Kpodar, Dawit Tessema):
  - Protecting investment spending during consolidations is contractionary in the short-term but boosts medium- to long-term growth.
  - Growth benefits are particularly large when the initial public investment ratio is low.
  - Increasing the share of public investment in total government spending from 10 to 20 percent raises medium-term growth by 0.5 percentage points.
  - Results hold both during good times (when consolidations are observed) and bad times (when consolidations are warranted).
- Chapter 9 — "Building Resilience to Natural Disaster in Vulnerable States: Savings from Ex-Ante Interventions" (Wei Guo, Saad Quayyum):
  - Dynamic, general equilibrium, and empirical models calibrated to six small highly vulnerable countries indicate net present value savings from investing in ex-ante resilience versus paying large recovery costs.
  - Increasing the elasticity of output to infrastructure via improved governance yields sizable output gains from the baseline.
  - Policy implication: Mobilize more resources to build resilient infrastructure against natural disaster and climate change.

### Debt, Investment, and Growth in Developing Countries with Segmented Labor Markets (DIG-Labor models)
- New DIG-Labor models extend the DIG framework with segmented labor markets, efficiency wages and open unemployment, and an informal non-agricultural sector.
- Enables analysis of macroeconomic and fiscal policy impacts on labor market outcomes, inequality, and poverty.
- Application: Analysis of big-push public investment programs with varying mixes of human capital and infrastructure investment.
  - Finding: Human capital investment is more effective in promoting long-run economic development when investments earn their average estimated returns.
  - Trade-off: Alternative investment decisions involve an acute intertemporal trade-off.
  - Ranking of investment programs depends on the policymakers' social discount rate and on the weight of distributional objectives in the social welfare function.

### Adapting to Climate Change in Sub-Saharan Africa (April 2020 REO chapter)
- Using dynamic stochastic and general equilibrium models, the chapter shows:
  - Unit cost of building resilience for climate adaptation is slightly more expensive initially.
  - After frequent disaster shocks, net saving from resilient infrastructure constructions offsets the higher unit cost.
  - Financing resilience is more desirable via broad-based adaptability and economy-wide financing to share disaster risks, financial burden, and reduce regional inequality.

### Firms, Failures, and Fluctuations: Macroeconomics of Supply Chain Disruptions
- Model features non-competitive markets with customized supplier-customer relations and bargaining over relationship-specific surplus.
- Key findings:
  - Changes in productivity alter surplus distribution and determine which firms are at the margin of failure.
  - Firm failures can spread to suppliers, customers, and other parts of the production network, amplifying negative shocks.
  - Paper provides existence, uniqueness, and comparative statics results on how equilibrium production networks propagate recessionary shocks.

### Tropical Cyclones and Post-Disaster Reconstruction of Public Infrastructure in Developing Countries
- General equilibrium model of a small open economy highlights links between public infrastructure and private capital.
- Calibration to data from the Caribbean Catastrophic Risk Insurance Facility examines reconstruction financing options: reserve depletion, budget reallocation, sovereign disaster insurance, debt, and taxation.
- Findings:
  - Disaster insurance plays a limited role in financing reconstruction.
  - Budget reallocations can be damaging, especially if they cannibalize operations and maintenance expenditures.
  - Absent donor grants or concessional borrowing, tax financing—where feasible—remains the least damaging instrument, particularly if the country risk premium on external debt is high.

### The Minimum Wage Puzzle in Less Developed Countries
- Dynamic general equilibrium model with efficiency wages and endogenous capital accumulation in formal and non-agricultural informal sectors replicates empirical evidence on binding minimum wage effects in middle-income and emerging market developing countries.
- Extension to a stylized low-income country shows:
  - Channels through which minimum wage regulations may have distinctly inferior and possibly adverse aggregate output and welfare effects in low-income countries compared to middle-income countries.

### How Large and Persistent is the Response of Inflation to Changes in Retail Energy Prices?
- Based on novel monthly data covering more than a hundred countries over 2000 to 2016 (Chadi Abdallah, Kangni Kpodar).
- Findings:
  - Inflation responds positively to retail energy price shocks; effects are, on average, modest and transitory.
  - Significant heterogeneity in inflation response due to differences in labor market flexibility, energy intensity, and monetary policy credibility.
  - Evidence of asymmetric effects—under sufficiently large shocks—in high-income and low-income countries: increases in retail fuel prices induce larger effects on inflation than decreases in fuel prices.

### Monetary Policy Frameworks: An Index and New Evidence
- Presentation at NBER Summer Institute (July 9) showcased methodology and an index capturing the soundness of monetary policy frameworks (D. Filiz Unsal, Chris Papageorgiou, Hendre Garbers).
- The index:
  - Detects key patterns of monetary policy frameworks across countries and over time.
  - Goes beyond simple categorizations based solely on monetary policy or exchange rate regimes.
  - Is particularly valuable for examining how monetary policy is conducted in emerging market and developing economies (EMDEs), especially amid COVID-19 where many countries modernize or experiment with eclectic regimes with multiple objectives and instruments.

### (In)efficient Credit Booms: The Role of Collateral
- Working paper by Diego Anzoátegui, Joseba Martinez, Pau Rabanal, D. Filiz Unsal presents a simple model generating credit booms via relaxation of credit standards tied to collateral availability.
- Key contributions:
  - Model matches key empirical facts about credit booms.
  - Establishes a link between collateral availability and choice of credit standards.
  - Identifies a new source of inefficiency related to credit supply decisions.
  - Policy implication: There is room for macro-prudential policy even without sharp increases in asset prices.

### Central Bank Communication and Monetary Policy Framework Through COVID-19
- Internal policy note "Central Bank Communication Through COVID-19" (D. Filiz Unsal, Hendre Garbers) outlines a three-part communication approach for central banks during crises:
  - Properly announce crisis measures.
  - Reiterate these measures as part of the regular communication cycle.
  - Articulate them within the broader monetary policy framework.
- Goal: Safeguard existing monetary policy frameworks, maintain longer-term focus on price stability, and preserve credibility.
- Presentation highlights:
  - Soundness of a monetary policy framework affects a central bank's ability to deal with shocks; the central bank’s response to shocks in turn affects framework soundness.
  - Communication is central to safeguarding frameworks and credibility through COVID-19.

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_Source: https://www.imf.org/-/media/files/topics/lics/macro-research-for-development/newsletters/sep2020.pdf_