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The possible effect of a virus on our economy: The Banking Industry in Chaos

            As a student interested in studying the economy and plans to major in this discipline, I would like to share a story of a possible, albeit improbable scenario of how a virus could affect the economy.

Someone walks into a store and tries to make a purchase using a debit card she uses every day.  This transaction is denied citing lack of funds in the account.  The customer becomes upset because she knows there is money in her account.  At her bank, she is informed her account balance is zero but that a computer virus has compromised the bank’s computer system, affecting thousands of accounts.  Large numbers of this bank’s customers are unable to use credit, debit or ATM cards.  Word is spread on social media that everyone with an account with this bank could become a victim.  People begin showing up at the bank to demand their money.  The bank is not prepared for this type of demand for currency. Again, social media spreads the word that this virus could possibly affect all banks.  Now there is run on banks in the United States by people who want to remove their money from bank accounts.  Two possible scenarios exist.

The first involves the effect of this run on banks on economic growth.  It will cause an increase in the demand for currency in the money market, where money supply interacts with money demand.  Unless the Federal Reserve takes action by implementing an Expansionary Monetary policy such as purchasing government securities, nominal interest rates will increase.  This will cause companies to lower borrowing to fund investment in capital stock such as new machinery and new factories.  With the lack of new production capabilities, new jobs and economic growth in general will not occur or at least not to the level it could be.

The second scenario is that this computer virus can cause what economists call the “crowding out effect”.  This will affect the loanable funds market where the supply and demand for loanable funds fight a constant battle.  People who save money in banks provide the supply and people who borrow money provide the demand for loanable funds.  As many customers seek to retrieve their money from banks, this will cause a decrease in the supply of loanable funds.  Lowering the supply will cause an increase in the real interest rate.  With the real interest rate higher, private borrowing will be “crowded out” as individuals won’t borrow as much money to buy higher priced items.  This could be far-reaching and affect industries whose sales depend on interest-sensitive consumption such as automobiles and homes.

The scenarios presented above are worst case but are examples of what could happen as the result of an attack on the banking industry.  Its effects would not be limited to financial institutions but also to other parts of the economy as people react to the threat that this virus would bring.