Question

Fiscal Policy in Response to the Coronavirus Crisis:

Many governments’ economic policy responses to Covid -19 have been rapid and extensive. The fiscal packages so far have aimed at cushioning the immediate impact of the sudden drop in economic activity on firms and households, and to preserve countries’ productive capacity. Among the measures introduced thus far by most countries are:

1. Maintaining business cash-flow,
2. implementing wide-ranging measures to help businesses retain their workers,
3. Providing income support to households, and
4. Easing access and expanding eligibility to sick-leave benefits and broadening the coverage of unemployment benefits to self-employed workers are amongst these.

(C) Next, you are to discuss three things:

(i) Explain clearly the concept of coordination between monetary and fiscal policy in the context of Covid-19.

(ii) Using the IS-LM model illustrate the above coordination to support your answer to part (i).

(iii) Has there been a coordination effort between the two policies Canada? Defend your answer.   (150 words + the diagram)

Answer 1

i) Coordination between monetary and fiscal policies of governments all over the world has been quite similar with respect to reducing the impact of COVID-19 on their respective economies. The better planned countries mostly the developed ones with higher per capita incomes will get out of this pandemic by the late 2021 however the ill planned ones will continue feeling the after effects even till 2023.

Most of the countries around the world have sought to balance the monetary and fiscal policies so that the economy whether be in vain still manages to feed the population it supports and the businesses too.

Monetary policies include:-

Most of the central banks around the world have lowered their policy rates varying by several base points. The reduction of reserve requirements and capital conservation buffers along with a temporary relaxation of provisioning rules has been implemented.

Central bank is offering loans to financial institutions backed by a private corporate bonds as collateral.The central banks have signed SWAP facilities with the US Fed for provision of US dollar liquidity. Separate funds have been created to save the SME sector from further crisis. Insolvency measures have also been taken by the governments.

The norms related to debt default on rated instruments and the required average market capitalization of public shareholding and minimum period of listing has been relaxed. A continuous repo operation is active in most of the countries for over a month.

Fiscal Policies

Penalties on certain legislation has been removed temporarily and to increase money supply in the economy the governments are turning in money in the hands of the people from it own borrowing from the central banks. Taxation has been lowered and the filing dates have been shifted for about a quarter.

The governments have committed vast packages amounting to 6 – 25% of GDP to increase money supply and support the private sector by reducing various government fees. Certain % of the costs of SMEs will be provided by the government in the form of incentives. Social Benefit programs and the healthcare needs has been taken in care by the government for every citizen in the developed countries.

Public spending on Infrastructure has been increased so as to boost the morale of investors and industrialists within the country.Unemployment benefits were extended to many people. Cash transfers to low income households and insurance coverage for workers in the healthcare sector wage support to daily wage workers has been undertaken too.

The two in coordination aim to bring the various economies back on track with the World Bank and IMF predicting a V shaped recovery for some of the nations too.

ii)

The dotted IS LM curve is the one which the central banks expect to do during the pandemic as interest rates fall leading to higher GDP as people will be better armed against the pandemic with higher levels of income which is due to less taxation on income and increased government expenditure.

The LM curve is rising due to being part of the expansionary policies which increase the money supply in the economy.

Hence it can be interpreted as such.

iii)

Similar coordination has been aimed at even Canada also. With fiscal policies including commitment of 16.4% of GDP to the i) health system for R&D and proper treatment of all the affected individuals and the indigenous people too.

ii) Households in direct aid including the above mentioned wage subsidies payments to workers without sick leave and increase in GST credits too.

iii) In liquidity support to the economy in the form of tax deferrals.

Monetary policies too include-

Reduction of policy rates by several base points.

Extending the bond buyback program across all maturities.

SWAP facility for liquidity of US dollars.

Credit facilities to firms under stress and additional support in lending capacity especially to producers, agribusinesses and food processors.

The central bank also aims to bring the economy to pre covid levels using the expansionary monetary and fiscal policies which include direct money to the households lower taxation etc so that if not less than the previous equilibrium then atleast till the previous equilibrium.

The IS curve is the curve before covid and IS2 curve is the one which the government expects to do to save the economy.

Similarly LM is the curve before covid and LM2 is the one which the government expects as a result of the policies followed by them.

The IS curve shifts right because of decreased taxation and increased government spending on the infrastructure and various social benefit programs.

The LM curve shifts right due to expansionary policy of the government to increase money supply in the economy so that demand doesn't dwindle and affect the GDP.