The COVID:19 (aka coronavirus) is hitting all aspects of human civilisation, including the global economy and international financial system. The outbreak of the pandemic has led to a sharp reduction in economic activity and turmoil in the financial markets. Its adverse economic impact is being felt at present and will continue in the days, months and years ahead. To minimise the damage, central banks and governments have tried to step in, with a substantial increase in monetary easing. The Bank of England has decreased the bank rate to 0.1% and launched a new Term Funding Scheme with additional incentives for small and medium enterprises. The financial-policy committee of the Bank of England has also reduced the countercyclical capital buffer for UK banks to a 0% rate for at least 12 months, with an expectation that it will result in a substantial increase in lending.
Similar actions were taken by other central banks. The US Fed has reduced the target range for the federal funds rate to 0 to 1/4%, and intended to increase its holdings of Treasury securities by at least $500 billion and its holdings of agency mortgage-backed securities by at least $200 billion. The European Central Bank, in its initial reaction, chose to keep the already below-zero policy rates unchanged, and instead announced the rolling out of cheap loans for eurozone banks (as low as -0.75%). It will also expand its balance sheet by beefing up its asset-purchase program, resulting in additional purchases of €120 billion until the end of 2020.
In parallel to the monetary authorities, governments have also taken an expansionary stance. The British chancellor of the exchequer has announced an extraordinarily expansionary Budget 2020, with huge spending commitments exceeding half a trillion pounds (£640 billion). Mr Trump is also seeking a US$ 850 billion COVID-19 related fiscal stimulus package. The European Council has decided to take fiscal measures of about 1% of GDP on average for 2020, and provision of liquidity facilities of at least 10% of GDP, consisting of public guarantee schemes and deferred tax payments.
Now the big question is, ‘will these monetary and fiscal measures be able to control the damage?’ But before we try to answer that, we must clear our doubts about one thing. The COVID-19 is not our usual economic or financial boom and bust. Unfortunately, it is something unprecedented, a lot deeper and complicated.
Choices for the monetary authorities have been very limited since the global financial crisis of 2008. They have tried their conventional and unconventional tricks, and there has been a debate whether central banks have already run out of ammunition. Major central banks, including the Bank of England, Bank of Japan, European Central Bank and the US Fed have already expanded balance sheets with asset holdings in trillions. Policy rates are already at the zero lower bound in most of the economies, and where they went negative, such as in Japan, Sweden and the eurozone, they did not go very far below zero. Nonetheless, in a crisis like COVID-19, having very large negative policy rates will just penalise savers and distort the markets. While the efforts by the monetary authorities are appreciable, their effects start to appear with lags. The coronavirus, however, does not follow these lags and the transmission increases exponentially.
In our usual textbook recession, we are all Keynesian. But this is not a textbook recession or financial crisis. While announcing a further £350bn lifeline for the economy, the chancellor of the exchequer Rishi Sunak argued that “we have never in peacetime faced an economic fight like this one”. Unfortunately, he seems to be correct here. Given the unprecedented nature of the crisis, our textbook fiscal expansion may not work here for various, but mainly two, reasons. First, fiscal policy, which involves government infrastructure investment, also comes with long lags, not comparable with the pace of the pandemic. Second, conventional fiscal policy, which stabilises the economy by enhancing economic activity and boosting growth, may not work here as the COVID-19 is causing economic activity to cease. The official advice is to limit economic and social activities and, in an environment like this, the conventional fiscal policy of putting people in work may not work.
So, what shall be the solution? As the COVID-19 has brought a whole set of new challenges, it requires new policy initiatives. First, trade policy. It is vital that the trade war which was in the news before the COVID-19 hit be changed into trade peace and cooperation to enhance global trade. The increased movement of goods may partially compensate for the sharp reduction in the movement of people and dampen the damage to global economic activity.
Second, monetary policy. The monetary authorities shall play not only the “lender of last resort” role but must also stand ready to provide liquidity as well as absorb the losses associated with the COVID-19. Lastly, fiscal policy is where the buck stops. Instead of solely relying on the conventional anti-recession measures of increasing public investment, which remains a good medium- to long-term idea under COVID-19, it is vital that fiscal policy becomes more inclusive and innovative. This shall include increased transfers to households, tax relief to households and firms, increased support to local authorities, reduction in consumption taxes, further support to health and social care. This might be more difficult in the eurozone, but there are ways to create much needed fiscal space in the eurozone and fix its design flaw.
The COVID-19 is a global issue and it is vital that global financial intuitions, including the IMF and the World Bank, play their part. In the post-global financial crisis world, governments, particularly in the eurozone and in developing countries, have been holding a large amount of sovereign debt. This is the time that these highly-indebted nations are relieved of this burden by the international financial institutions, so they can join the global efforts in effectively fighting the COVID-19.
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Muhammad Ali Nasir is senior lecturer in the department of economics, analytics and international business at Leeds Business School, Leeds Beckett University.