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Which Economic Stimulus Works?

During the initial shock from COVID-19, it was understandable that governments and central banks would respond with massive injections of liquidity. But now policymakers need to take a step back and consider which forms of stimulus are really needed, and which risk doing more harm than good.

NEW YORK – Governments around the world are responding forcefully to the COVID-19 crisis with a combined fiscal and monetary response that has already reached 10% of global GDP. Yet according to the latest global assessment from the United Nations Department of Economic and Social Affairs, these stimulus measures may not boost consumption and investment by as much as policymakers are hoping.

The problem is that a significant portion of the money is being funneled directly into capital buffers, leading to an increase in precautionary balances. The situation is akin to the “liquidity trap” that so worried John Maynard Keynes during the Great Depression.

Today’s stimulus measures have understandably been rolled out in haste – almost in panic – to contain the economic fallout from the pandemic. And while this fire-hose approach was neither targeted nor precise, many commentators would argue that it was the only option at the time. Without a massive injection of emergency liquidity, there probably would have been widespread bankruptcies, losses of organizational capital, and an even steeper path to recovery.

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