Question:
Of course, as you know, the entire world has been massively affected by the coronavirus, including the world's economies. Recession will be a huge problem for many countries, even the richer countries such as the US and the UK. So my, perhaps ignorant question, as a 15 year old is - since every country will be negatively impacted by the virus, what would happen if the entire world, or close to it were to decide to just lower the price of everything, the price of buying everything, manufacturing everything, and everyone's salaries are lower too in comparison. Would that solve anything? As after all, the world's economic figures are just numbers, but could cause so much harm to everything and everyone in that country.Answer:
The way in which prices and money enter models of the economy is important and potentially confusing. So this is a great question.
In most models, lowering (or raising) all prices, including the price of labor (wages) would have no effect on economic activity or transactions. What matters for people are the relative prices of goods (how much rent costs compared to income, etc.). For example, if monthly income is $2,000 and rent is $400; and then these prices and all others are reduced by half, so income is $1,000, and rent is $200, the only thing that would change is the “nominal” value of the transaction and also the nation’s Gross Domestic Product.
Most of the time, however, not only is the overall level of prices changing, but relative prices are changing too. For example, as people are driving less and oil production has been high, the cost of gasoline has fallen. These relative changes encourage changes in behavior—in this case falling prices should encourage more driving and less oil production.
In the current virus situation, the shock to the economy is complicated. The supply of many goods is being reduced because people cannot work safely (for example, waiters, beauty parlor workers, etc.) and those businesses have closed. These workers are losing income and so cannot afford to buy as much, which means the demand for all the things they purchase (for example, groceries, rent, clothes) has been reduced. In turn, this reduces income for everyone else in the economy who produces and sells these goods.
Adjusting the overall price level won’t help with this. So, to return to your question, lowering the prices of everything won’t help to recover output or solve the current crisis. As long as there is a major risk of becoming infected production cannot go back to its normal level and incomes will be reduced. Instead, economic policies like unemployment benefits help workers to cope with the loss of income from unemployment, and loans to businesses help them to pay their suppliers. These approaches soften the effects of the temporary disruption.
