The most extreme monetary and fiscal policy changes due to Covid

November 25, 2020

By ForexNewsNow

Central banks have been at the forefront of combating the economic consequences of the spread of COVID-19. However, the reason for the shock is not financial, and the longer it lasts, the less the monetary authorities have the capacity to eliminate its consequences. However there are some positive news, as we have already several vaccines that provide a high level of effectiveness.

During the first quarter of 2020, the vast majority of OECD central banks, which include 36 countries, relaxed interest rates. The median value of the rate cut (excluding Argentina, where inflation is raging) was 25 bps. Among the developed economies, the exception was the Swedish Riksbank and the National Bank of the Czech Republic (first on February 7 raised its key rate by 25 bps due to inflation risks, but on March 17 hastened to reduce it by 50 bps). The Central Bank of Denmark was forced to reduce the negative value of the deposit certificate rate from minus 0.75% to minus 0.6% to protect the fixed rate of the krone and narrow the interest differential with the eurozone to 10 bps. They were forced to raise rates to protect the national currency and because of accelerating inflation.

The Bank of Russia in February lowered the key rate by 0.25 bps, in March kept it at 6% and softened the conditions of reserve formation, expanded the refinancing program for small business loans, froze the revaluation of the value of securities, poured additional liquidity into the banking sector, began pre-emptive sale of foreign currency from the National Welfare Fund and adopted a wide range of other measures, jointly with the government.

The overwhelming number of central banks has softened interest rates on an extraordinary basis and by significant amounts. Given that in the economically developed countries interest rates have reached the near-zero levels, and in the eurozone, Japan, Switzerland have entered the negative zone, the possibility of further easing is extremely limited. In particular, in the USA, Great Britain, Australia, Sweden, Israel rates are already in the range of 0 to 0.25% and any noticeable subsequent decline is no longer possible.

Pandemic asset buyback

The European Central Bank has announced a massive “pandemic” program of buying government and corporate bonds for 750 billion euros by the end of 2020. At the same time, the ECB Board of Governors noted that it will stop buying assets when there are signs of the end of the acute phase of the viral crisis.

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The Bank of England has announced a 435 billion pound government bond buyback and a 10 billion pound corporate bond. The Bank of Japan has spent 1.3 trillion yen ($12 billion) buying government bonds to curb their yield growth. Sweden’s Riksbank plans to buy $29 billion worth of government, municipal and mortgage bonds, in addition to the $33 billion it already has on its balance sheet after the previous round of quantitative easing. The Bank of Canada will purchase $357 million worth of mortgage bonds a week until “market conditions stabilize.” The Bank of Israel intends to buy government bonds on the secondary market for various terms to ensure the “smooth functioning of the market.” The Reserve Bank of New York has announced a program to buy back government bonds in a volume comparable to 10% of the country’s GDP.

Managing the interest rate curve

A distinctive feature of monetary measures against COVID-19 was the targeting of medium- and long-term yields of the national debt by central banks.

The pioneer back in 2016 was the Bank of Japan, which officially keeps the yield of ten-year government bonds at 0%. In March, it was joined by the Reserve Bank of Australia, which set a target yield on three-year government bonds no higher than 0.25 per cent – as much as the central bank’s rate itself. Procedurally, they will be regular auctions on the secondary bond market.

The policy of operating targeting the yield of government bonds is not directly related to quantitative easing. The central bank does not set any quantitative targets for asset buybacks or the size of its balance sheet. The retention of the medium- and long-term yield of the national debt is designed to reduce the cost of borrowing in the debt market.

Special credit instruments

A number of central banks have decided to put in place additional refinancing tools with a focus on small business. A similar program has already been tested by the Bank of England

The European Central Bank will refinance loans to small businesses by 25 bps below the rate on major operations. A special tool should stimulate credit supply in the target market.

In a number of economies where there are no developed financial markets, monetary policy relies in part on combined management of short-term interest rates and cash aggregates. In such cases, in order to increase the money supply, the authorities have reduced the mandatory reserve requirements. In particular, the Central Bank of Malaysia reduced the rate of mandatory reserves from 3 to 2%, the authorities of Indonesia and Iceland took similar measures.

Conclusion

It is obvious that the disease is not “treated” by cash injections of central banks, from the reduction of rates and purchase of bonds patients do not recover, and healthy do not go to work. The crisis can be stopped through research, the release of tests and drugs, as well as mass health care for citizens. The best way to restart the global growth engine is to smooth the curve of virus infection, both in individual countries and around the world; this, rather than the monetary and fiscal policy, should be the focus of politicians. Thus, the efforts of central banks will be enough to resist short-term troubles, but if the coronavirus epidemic drags on, money pumping to the economy will not help.