Question

Summarise the various forms of monetary policy responses to the current pandemic around the world. Given these responses, what are the risks of the current stimulus policies?

Answer 1

Monetary policy:

This is the policy of the central bank of the respective country. Required policy is taken for making the economy stabilized. Basically there are two types of monetary policy – expansionary (stimulus), and contractionary.

The current pandemic makes a huge financial downturn throughout the world. So many lockdowns and restrictions in all form of activities are making the economy passing through a recession. This is the reason why central banks take stimulus policy for rectification.

Forms are as below:

#) Reduction in required reserve ratio: a portion of demand deposits in banks are to be kept as reserve compulsorily, known as required reserve. This ratio could be reduced so that there would be excess money to be in lending by commercial banks. It increases money supply and can make the economy stable.

#) Purchase of govt. bonds and securities: this is also an increasing money supply process, since the purchase is done in exchange of money.

#) Discount rate reduction: this is the rate at which commercial banks take loans from their respective central banks. Once the rate is reduced, the payment burden (interest amount) would be low for those banks. They would be having excess money in hands for lending, which increase money supply.

Risks:

There are some risks associated with such stimulus policy. These are as below:

#) Inflation rate: it may increase very fast in near future, since the increasing money increases purchasing ability of consumers. Since supply can’t be increased immediately, it creates pressure on price level, causing inflation.

#) Real growth: it may fall, since inflation increases. Real GDP is the indicator of growth. If it falls, the cost of living may increase.