Question

• Interest rates are at historic lows in many countries—in some cases, close to zero. How is expansionary monetary policy, or more specifically an open market purchase, supposed to work? How do near-zero interest rates limit the ability of expansionary monetary policy to work?
• In your opinion, how effective has the Australian Government’s policy been as a response to the economic downturn due to the Covid-19 situation? What evidence can you suggest to support your position?

Answer 1

Interest rates are at historic lows in many countries—in some cases, close to zero. Expanding the money supply in the economy through open market purchases right now will lower interest rates enough for crucial investments in the economy to continue. How does this help at a time like the COVID-19 pandemic? The rising costs of borrowing due to the pandemic are at least offset to a certain extent by lower interest rates thus creating an incentive to borrow to take advantage of economic opportunities created during that time period which would otherwise be left undercapitalized. The business sector is naturally more risk taking than the rest of the economy and this incentive mechanism lowers the risk threshold enough at times for the sector to increase participation.

Near zero interest rates mean that central banks do not have the ability to push the economy up through the standard expansionary means. The inability to lower interest rates in the short run could allow a sudden and unexpected fall in the demand for goods and services to push the economy into a deflationary spiral, a situation in which falling prices and falling output feed upon each other. If the cratering prices cause a deflationary shock, output would soon follow suit thus creating a black hole like spiral.

The Australian Government has taken several measures to respond to the downturn caused by the pandemic. The Australian government is subsidizing wages for workers which means that there is a temporary reduction in potential layoffs. This is a potentially dangerous strategy since the government could potentially be keeping dead jobs alive (Jobs which have been rendered obsolete and gone permanently). The potential long-term cost in terms of the doubling of public debt due to the cost of the stimulus packages is that the Australian government will need to accept a higher debt to GDP ratio for a long time or decrease spending in the medium run after the pandemic is over.

The government has also developed public private partnerships in order to make PPE which has been effective as more than 13 companies have collaborated on this project. This policy is great since it creates jobs out of the pandemic which is a potential upside to an otherwise disastrous year. The federal government has introduced Job Keeper payments which have merely delayed the inevitable drop in property prices. The short run benefits are tremendous since depression level unemployment has been staved off and long-term solutions can be found and the cost of those spread out as compared to a potential short run spiral which could have potentially become permanent.

The policies introduced by the government are equitable since they put human rights and basic economic rights of workers above fiscal deficits but the increase in spending could potentially have limited long term costs since the Australian government started off with much lower debt to GDP levels as compared to the rest of the developed world.