Solidarity in the time of COVID-19 -- MS Supplement

Fighting major crises: Fiscal policy vs. monetary policy

"The debate must, in this instance at least, be decided in favor of fiscal policy."


The way things are looking, the world economy is headed for a downturn of very serious proportions. Just how serious the downturn will be—whether or not it will be categorizable as a depression—will depend on how quickly the Covid-19 outbreak is contained.

The world has been fighting two wars concurrently: the medical war of containing the corona virus outbreak and the economic war of keeping the world economy from going into a deep downturn. While the medical war is being fought, the economic war has become more complicated and more pain-filled with every passing day. The bad things that had been happening to the economies of an increasing number of countries—the losses of demand, incomes, profits and jobs—have suggested to the world’s economic policymakers that the coming downturn is going to be deep and prolonged. Accordingly, the heads of treasuries and central banks around the world have set aside the usual operational limits and have begun to think mainly in fiscal-policy terms.

In the most recent monetary deployment, the world’s No. 1 central bank, the US Fed (Federal Reserve Board) has announced a policy of QE (quantitative easing) that is more far-reaching than the QE policy that it brought into play in the 2008 global crisis; the new Fed policy is virtually a no-limits policy. Prior to the recent action of the Fed, several other major central banks had positioned themselves for a monetary assault against the corona virus pandemic, allowing special lending programs for small-business and other special borrowers and reducing their interest rates to near-zero levels.

There has been a continuing debate about the comparative efficiencies of economic policy tools among practitioners of crisis-time economic policymaking. Some practitioners argue that monetary policy tools are better for crisis-solving; others contend that policy actions of a fiscal nature are preferable for dealing with COVID-19-type situations.

The principal function of a central bank is to manage the money supply in order to ensure that the supply of money will be at a level sufficient for (1) the accommodation of all legitimate emergency demand for funds and (2) the maintenance of general price stability. A central bank undoubtedly has a very important role to play in the kind of economic environment in which many countries find themselves today, but the bad things that are taking place in most economies with frightening rapidity—business closures, layoffs, food shortages, etc.­—are not the kinds of things that are turned around by measures such as more easily accessible loans, lower interest rates and required-reserve ratio (RRR) reductions. These measures are very helpful but at a time like the present, with bad economic news following one another in quick succession, what are needed most are policy measures of the quick-disbursing kind.

This is because monetary policy does not lend itself easily to need-for-quick-response situations. True, in this country a Monetary Board resolution is all that is needed to make a larger quantity of lower-cost money available to the banking system, but banks just do not stuff money into the pockets of those who, in an emergency, need financial rescue urgently. Those who are in direst need of emergency financing—the small and medium-size enterprises (SMSEs) that have stopped operating and the workers whom they have been forced to dismiss—must first file loan applications, which the banks then subject to processing. This defeats the whole idea of emergency financing, the essence of which is quickness.

The foregoing discussion presupposes that loan-experiencing SMSEs and dismissed workers are inclined to seek, and banks are inclined to grant, loans during economically stressful times, like the present. This, usually, is not the case. Workers who have just lost their jobs usually are disinclined to incur more debt, and banks usually are unwilling to grant loans to such individuals.

The long-running debate regarding the comparative worth of monetary policy and fiscal policy—whether one is superior, overall, to the other as a means of restoring economic stability—is being sharpened by the progressive deterioration by the world’s largest economy, the US economy, occasioned by the COVID-19 pandemic. Can central bank measures mainly do the job of stopping the deterioration? Or is fiscal action by the government, especially quickly-disbursed grants and benefits, required to bring a bad economic situation under control?

Given the speed with which demand and production are drying up because of the worldwide lockdowns, the debate must, in this instance at least, be decided in favor of fiscal policy.

Topics: Rudy Romero , US Fed , Federal Reserve Board , small and medium-size enterprises , SMSEs , coronavirus disease 2019 , COVID-19
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