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Macro policies to prevent an economic depression

Level:
AS, A Level, IB
Board:
AQA, Edexcel, OCR, IB, Eduqas, WJEC

Last updated 21 Mar 2020

In this special video we reflect on the fiscal stimulus announced by Chancellor Sunak in the UK. Will it be enough to mitigate some of the hugely damaging fallout from the Coronavirus pandemic?

Macro policies to prevent an economic depression

Coronavirus is a demand and a supply-side shock

  • This is a public health crisis with severe economic consequences. The two are inextricably linked
  • International Labour Office forecasts that global unemployment may rise by 25 million or more
  • Supply-side shock: Impact on production, supply chains, employment dropping as factories close (temporarily we hope)
  • Demand-side shock: Private sector demand dropping sharply (C+I+X) – decline in animal spirits / consumer and business confidence
  • Demand shocks then lead to Keynesian multiplier - like amplification

Limiting the risk of economic depression

  • How resilient are systems faced with radical uncertainty and stress?
  • Coronavirus crisis has struck at a vulnerable time in the world economy
  • The ten nations hit hardest by COVID-19 is almost identical to the list of the ten largest economies in the world (Iran and India are the exceptions)
  • US, China, Japan, Germany, Britain, France, and Italy account for:
  • 60% of world supply and demand (GDP)
  • 65% of world manufacturing
  • 41% of world manufacturing exports
  • When private sector demand and employment collapses – we look to monetary and fiscal policy to act as a vital counter-balance

Monetary and Fiscal Stimulus / Mitigation in Action

Monetary Policy (Bank of England):

  • Base interest rates cut from 0.75% to 0.1%
  • Quantitative easing expanded by £200 billion including purchases of corporate debt

Fiscal Policy (Round 1)

  • Government guaranteed interest-free loan scheme for businesses (12 months)
  • £25,000 cash grants for smaller businesses in hospitality & leisure industry
  • Mortgage holiday for 3 months
  • Abolition of business rates for 2020 for hospitality, retail and leisure sectors

Fiscal Policy (Round 2)

  • Coronavirus Job Retention Scheme: Government grants to cover 80% of the salary of retained (furloughed) workers up to a total of £2,500 a month
  • Deferral of business VAT payments until the end of June2020
  • Universal Credit standard allowance, for the next 12 months raised by £1,000 a year.

Brief evaluation thoughts and questions

  • Nominal interest rates have fallen to the floor in developed countries – but they didn’t have much to fall (a legacy of the response to the last crisis)
  • Advanced countries are likely to be in a liquidity trap where zero interest rates have little impact on components of aggregate demand
  • Keeping people in work and preventing viable businesses from going under is essential – most businesses fail because they run out of cash
  • If fiscal policy doesn’t do enough to prevent depression, then prices will fall, and real interest rates will rise – making the depression worse
  • Monetary and fiscal policy are becoming one for the moment – e.g. central banks financing the unprecedented fiscal stimulus (“filling the hole”)
  • Might central banks ultimately be the vehicle for universal basic income?

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