The Federal Reserve vs. COVID-19

Written by: Ehab Khan and Ahmed Aamir

LEC x UWES Research Writing Competition – Second Place

The COVID-19 pandemic has had a profound impact on the global economy, leading to widespread job losses, reduced economic activity, and a sharp contraction in many countries. In response, governments and central banks around the world have implemented a wide range of economic policies and models to support the recovery of their economies.

One of the chief policies used by many governments was monetary stimulus, in which central banks increased money supply and reduced interest rates to boost spending and investment. This was so the costs of borrowing were reduced, which in turn improves the purchasing power in the economy and encouraged spending. In certain countries, central banks also introduced new lending amenities to aid households and businesses. Some of the policies used by central banks also include quantitative easing and liquidity support.

Central banks have utilized interest rate cuts to aid the economy during the pandemic. The United States Federal Reserve cut interest rates to nearly zero. Quantitative easing was also used to support the government. The United States Federal Reserve made a program to purchase 700 billion in Treasury and Mortgage-Backed Securities. The European central bank launched a 750 billion Euro purchase program to purchase public and private securities.

Along with monetary stimulus, Fiscal Stimulus was also a policy instrument that was widely used by countries around the world. Examples include direct transfers to individuals like unemployment benefits and stimulus payments and investment in infrastructure to create jobs which was done by the US amid the pandemic. In some cases, governments provided financial support to businesses in the guise of loans, grants and tax relief such as Bolivia and India. Tax relief measures were also used to support businesses affected by the pandemic. For example, the United States government provide a tax relief for business that had high employee retention during the pandemic.

Along with policies, governments have used economic models as well with the aim to support the recovery all while minimizing risk and cushioning any drastic damages that could occur. Most countries have a “V-shaped” recovery model, in which the economy for that respective country is predicted to recover quickly once the pandemic is under control. Other countries adopted a “U-shaped” recovery model as an indication that it will not recover as fast as countries with a “V-shaped” model as they will recover more gradually with a focus on long- term economic stability

A notable economic model used amid the pandemic was the K shaped Recovery. Wherein different sectors of the economy naturally recover at different speeds due to demand within these sectors. This was particularly evident in the case of the E-Commerce and Technology sectors, who were able to thrive due to the populations reliance on both the industries. However, the tourist and hospitality industries struggles severely and therefore recovered very slowly.

Economic recovery is required to especially bring back the jobs of the lower income individuals who lost their jobs due to the pandemic. “Officials have mentioned that the target is to keep an average of 2 percent inflation in the economy by starting to have inflation above 2% for now” as stated in the article in the Bibliography. In order to keep that, government intervened to keep the interest-rates low of 0 – 0.25 percent to induce high borrowing and investments. “Interest is the amount of money a lender or financial institution receives for lending out money. Interest can also refer to the amount of ownership a stockholder has in a company, usually expressed as a percentage” (Chen). The rate of interest is decided by the central banks of each respective country.

The United States Federal Reserve has successfully kept its interest rate at an all-time low in response to the recovery economy due to Covid-19. There is a lot of economic activity due to the low interest rate and the stimulus package received by all families in the US.

In order for the economy to get to the potential output level central banks have intervened and implemented implement the expansionary monetary policy in order to AD the right. When central banks implemented the expansionary monetary policy, they would increase money supply and decrease interest rates. This would lead to an increase in consumption spending, investment spending and Aggregate Demand.

Figure 1: Increase in money supply

In order for the economy to get to the potential output level central banks should implement the expansionary monetary policy in order to shift AD to the right. When central banks implement the expansionary monetary policy, they would increase money supply and decrease interest rates. This would lead to an increase in consumption spending, investment spending and Aggregate Demand. However, the monetary policy also carries some weaknesses. In times of deep recessions, the banks would be fearful to lend money to consumers which would hamper economic activity and growth. Therefore, monetary policy doesn’t guarantee growth within an economy. When it comes to Monetary policy there is a risk of hyperinflation occurring due to encouraging investment, workers expecting higher wages, and simulate growth at all

levels of society. The interest rates being lower does not guarantee that the consumer confidence is going to go higher and in tun investment and consumption will increase.

Figure 2: Increase in AD

Due to the conditions of the US economy and the interest rates being low, aggregate demand shifts right and or increases from AD2 to AD3. This increase in aggregate demand however doesn’t mean that the economy is now in an inflationary gap where there is too much AD for the economy and the real output exceeds potential output at YP. Along with the AD the price would also increase However, since this is the Keynesian Model and not the Monetarist perspective, the increase in price level won’t be as significant as it would be in the graph of the Monetarist perspective. This is due to the shape of the Keynesian Model and how the price remains constant for majority of the horizontal part of the Curve. This would be crucial in the case of this article as they would need to make a small change considering the AD2 is close to the potential output therefore they wouldn’t be able to cause demand pull inflation due to shifting demand too high. “The significance of the expansionary monetary policy is to see how the government intervention by holding treasury securities by $80 billion per month and

mortgage-backed securities of $ 40 billion per month”. The intervention is to increase the money supply by creating extra measures to banks so, banks can provide money for private consumers at a lower interest rate. As. The government holds the securities, the cash is adding inti the banks funds of providing it for loans. “The Fed also said it will continue to increase its holdings of Treasury securities by at least $80 billion per month” which is also known as Open Market Operations.

There is a connection between the inflation and unemployment level, which is shown through a Philips curve. The Phillips curve is a graph showing that inflation and unemployment have a stable and inverse relationship.

Figure 3: Philips Curve

As the unemployment rate is close to 10 percent with 9 million Americans out of work. The Philips curve is a concept is relevant to see that the unemployment level will fall with an increase in inflation level. {The inverse relationship} however, it might only work in the short run as in the long run, the rate of unemployment becomes independent of inflation with the

unemployment level as the long run has automatic solution of increase in AD with a decrease in SRAS and the employment level stays constant with only change in price level.

In conclusion, the COVID-19 pandemic has had a profound impact on the global economy, and governments and central banks around the world have implemented a wide range of economic policies and models to support the recovery. These policies have included monetary and fiscal stimulus, as well as different economic models aimed at supporting the recovery while minimizing the risk of long-term damage. Ultimately, the success of these policies will depend on how well they are implemented, and how effectively they address the unique challenges posed by the pandemic. Intervention is relevant as the changes that the government would want to bring in terms of bringing in the economic recovery after the distance caused due to the pandemic. Apart from monetary policy change, there could be a use of fiscal policy to induce government spending in the economy. Another way to look at it is to look at the intervention using supply- side policies to bring in the change.

Works Cited

Ians. “US Fed Keeps Interest Rates near Zero amid Slow Economic Recovery.” Business Standard News, Business-Standard, 28 Jan. 2021, economic-recovery-121012800222_1.html/.

Ihrig, Jane E., et al. “How the Fed Has Responded to the COVID-19 Pandemic.” Saint Louis Fed Eagle, Federal Reserve Bank of St. Louis, 9 Dec. 2021, vault/2020/august/fed-response-covid19-pandemic.

“Policy Responses to covid19.” IMF, Responses-to-COVID-19.

Milstein, Eric, and David Wessel. “What Did the Fed Do in Response to the COVID-19 Crisis?” Brookings, Brookings, 9 Mar. 2022, covid19/.

Rashid, Hamid. “UN DESA Policy Brief No. 129: The Monetary Policy Response to COVID-19: The Role of Asset Purchase Programmes | Department of Economic and Social Affairs.” United Nations, United Nations, 9 Feb. 2022, monetary-policy-response-to-covid-19-the-role-of-asset-purchase-programmes/.

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