Monetary Policy of US to Fight Against COVID-19
COVID-19 refers to the pandemic caused by the virus SARS-CoV-2. It is more contagious than the traditional pandemic and will spread more easily among people. Different countries adopted different methods to deal with COVID-19, yet the economy around the world has been affected in spite of the policies local governments had adopted (Fox, 2021). In this paper, we will have a look at how COVID-19 has affected the US economy. Also, the student would investigate what monetary the US government had implemented to ensure social stabilization and reboot the economy. Plus, the efficiency of these policies will be evaluated.
It is widely acknowledged that COVID-19 has caused a global economic recession (Cox, 2019). Yet, it deserved our attention why the pandemic could result in such a Great Recession in the US. First, even if different states in the US might choose other methods, most states will implement lock-down and social distancing in 2020. That means the number of job positions would decrease. Thus, the unemployment rate would increase steeply, which is consistent with FRED’s data, known as Federal Reserve Economic Data (see fig. 1). Plus, citizens tend to save money faced with the uncertainty accompanied by COVID-19. Therefore, consumption would decrease in the US. Further, the stagnated stock market and the risk caused by COVID-19 had prevented numerous investors from investing. Consequently, the national GDP has decreased tremendously during the pandemic (Elliot, 2019). As FRED data denoted, the slump of GDP only happened in two periods: the financial crisis in 2008 and the Great Recession in 2020 (see fig. 2). Suppose the government could not take any actions. In that case, the average income of citizens will decrease, the unemployment rate would keep increasing, numbers of companies would face bankruptcy, and other severe social issues might arise (Jenkins et al., 1983). So, boosting the US economy had become one of the necessities for the US.
To fight against the recession, the central bank should adopt the expansionary policy (IMF, 2021). As known, expansionary monetary policy will increase the money supply or lower the interest rate. There are two major steps for the central bank to achieve the goal. The first step is open market operation. By buying debt securities, the central bank can lower the interest rate. In this way, the cost of borrow will be reduced for companies. Meanwhile, citizens are encouraged to purchase. Thus, investment and consumption will increase. The second step is quantitative easing. The interest rates on savings and loaning will be reduced (Bank of England, 2021). In other words, it encourages lending and investment. Besides open market operation and quantitative, the central bank also adopted discount lending to reduce lending and lower capital requirements to reduce the reserve rate of banks. Combing all those methods above, the interest rate has been lowered to a level near zero. Meantime, the market supply of money has increased (FRED, 2021). Due to the lower interest rate, consumption had been stimulated. Thus, the aggregate demand has increased, which will positively affect the employment rate. Accordingly, the GDP of the US would increase. As the data of FRED suggested, the unemployment rate has decreased since January 2021, and the GDP has increased since Q2 2020 (FRED, 2021). In a word, the expansionary monetary policy of the US performed well against the pandemic.
However, is there a method to evaluate the real efficiency of the monetary policy of the US? To delve into the economic model, we need to figure out the demand and supply change in the US society first. Although both demand-side shock and supply-side shock had taken place during COVID-19, the latter should have a greater influence on the US economy because a sudden drop of supply might affect numerous factories and retailers. Then, the employee of these companies would face a lower wage or unemployment. Thus, the supply-side shock might worsen the demand-side shock (Rio-Chanona et al., 2020). This process can be illustrated by Fig. 3 below. In order to treat the recession efficiently, policymakers should shift the supply curve to the right side. Yet, if only the supply increase while the demand does not change, the producers might face a market with higher quantity but lower prices. In this situation, ensuring the stabilization of price might be necessary because fluctuated prices will increase the difficulty of evaluating the product in a nation, aggravate the public panic, and worsen the recession (Hayes, 2021). As we’ve mentioned before, a lower interest rate will stimulate consumption and increase the quantity of money demand. Plus, if we look at the IS-LM model covered in ECON 4002.01, we may know that the expansionary monetary policy will shift the LM curve downward because of the lower interest rate and increased money supply. As a result, the output in society will increase, and the real income of citizens will increase, and the process can be denoted by the graphs below (see fig. 4). Accordingly, the total output will increase in the IS-LM model. Therefore, the expansionary monetary policy will reboot the economy.
There are some critiques about the expansionary monetary policy of the US, though. Some argued that the economy has a self-correcting mechanism, which means the total output of the society could recover to a healthy level even if the policymakers didn’t adopt the expansionary monetary policy. Economist Martin Feldkircher built the models with and without the monetary policy in response to this statement. The results are recorded as graphs as attached below. As his result suggested, the output growth would be even lower without the monetary policy (see fig. 5). Also, the equity return will be lower without these policies. (Feldkircher, 2021). However, some economists are still worried about the negative effects of low-interest rates and increased inflation. For example, investors may turn to risk-lovers when faced with a low-interest rate (Mester, 2021). Also, domestic currency may depreciate due to increased money supply and low-interest rates. Even if the net export might increase in this case, the domestic producers might take higher costs for imports. Thus, the profits of these producers might be even lower (Mankiw, 2017). Plus, a “liquidity trap” might occur during the recession, which means a society simultaneously has a low interest rate and high savings (Mitchell, 2021). Therefore, the policies might be ineffective. Further, an extremely low-interest rate may leave little field for the central bank to face potential recessions in the future. In a word, although expansionary monetary policy can boost the economy during the recession, the policymakers still need to take the risk of depreciation, an over-heated economy, and a “liquidity trap” into account and get prepared for these challenges.
To conclude, the US central bank adopted the expansionary monetary policy to fight against the recession caused by the COVID-19 pandemic. This includes open market operation by purchasing debt securities and quantity easing by purchasing bonds to reduce the interest rate and increase monetary supply. As a result, the unemployment rate in the US has decreased, and the GDP has increased, which proved the efficiency of expansionary monetary policy. However, we should still be aware of the potential risks, including an overheated economy, depreciation of the domestic currency, and liquidity trap.
References
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Fig. 5, “Series (Solid, Black) VS Counterfactual (Dashed, grey)”, Feldkircher, Martin, et al. “Measuring the Effectiveness of US Monetary Policy during the COVID‐19 Recession.” Scottish Journal of Political Economy, vol. 68, no. 3, 2021, pp. 287–297., https://doi.org/10.1111/sjpe.12275.
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