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The Limits of Extreme COVID Monetary Policy

Just because the major central banks can continue to introduce increasingly unconventional measures doesn't mean that they should. The current economic crisis demands primarily a fiscal-policy response, whereas extreme monetary policies carry high risks and produce adverse side effects.

LONDON – With output having collapsed as a result of the COVID-19 pandemic, many are wondering how far monetary policy can be stretched to support the economy. For the US Federal Reserve, negative interest rates appear to represent an effective limit, not because such a policy is technically unfeasible, but because it would be politically unacceptable. Yet for the European Central Bank, the Bank of England, and the Bank of Japan, there appears to be no limit.

The ECB has long since cut rates into negative territory, and BOE Governor Andrew Bailey is reportedly “looking very carefully” at that option for the United Kingdom. Likewise, BOJ Governor Haruhiko Kuroda, while deeming the BOJ’s current policy mix appropriate for current conditions, has not ruled out further monetary easing or another increase in asset purchases.

The question is whether it makes sense to go further down the road of extreme monetary policy. Former ECB President Mario Draghi’s famous promise to do “whatever it takes” to support the euro has now become the mantra for all policymakers confronting the current crisis. But wouldn’t expanding fiscal policy be a better way to fulfill that commitment? To paraphrase Fed Chairman Jerome Powell, central banks have lending power, not spending power – and spending is what is needed.

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