In addition to Fiscal Policy, Monetary Policy is another macroeconomic action to stimulate the economy during a recession. It is also a way to initiate an economic slowdown for an overheating economy. Since central banks are able to act quickly to use monetary policy tools, it is an easy and a common policy to implement. Thus, monetary policy has an important role during the coronavirus recession

Monetary Policy Strategies And Responses

Monetary policy essentially involves changing interest rates and controlling the money supply. There are three common tools of monetary policy. The first one is open market operations, in which the central bank buys and sells government-issued securities. These actions increase or decrease liquidity in the market and affect the interest rates. This change in the interest rates affects the aggregate demand in the country. For example if a central bank buys government-issues securities, the money supply in the market increases. This decreases the cost of borrowing and, thus, decreases the interest rates. In macroeconomy, a decrease in the interest rates also leads to a rise in aggregate demand. 

Second and Third Monetary Policy Tools

The second monetary policy tool is changing the reserve requirements, in which the central bank regulates the minimum amount of reserve that a commercial bank must hold. Through regulating the reserves, this policy also changes the money supply in the market like the open market operations. The third tool is the discount rate, which is the interest rate that the banks are charged to borrow from the central bank. All these tools can either be applied as expansionary or contractionary depending on the business cycle. 

Which Monetary Policies Did The Countries Adopt During The Coronavirus Pandemic?

In their article for Financial Times, Ben Bernanke and Janet Yellen stated that to avoid permanent economic damage, “it is important to ensure that credit is available for otherwise sound borrowers who face a temporary period of low income or revenues”1. Thus, until now central banks in many countries adopted policies that drastically lowered the interest rates. This policy mainly aimed to stabilize the markets and support affected businesses, along with slightly stimulating the aggregate demand. 

There have also been rumors that FED may try negative interest rates, a policy that seriously encourages lending to boost businesses and consumer spending. Previously Japan and countries in Europe tried negative interest rates and faced mixed results2. Since “there’s no clear finding that it actually does support economic activity on net, and it introduces distortions into the financial system,” Jerome Powell said the FED will not cut the interest rates to negative3

Another Possible Policy: Yield Curve Control

Yield Curve Control is another policy that can be implemented. With this policy, the central bank targets a longer-term interest rate and pledges to buy or sell bonds to achieve that target. Bank of Japan has been pursuing this policy since 2016 in their fight against deflation. Especially during the recovery period, since many businesses are severely affected, pledging lower interest rates for a longer time might be effective for recovery. According to Brookings, the experience in Japan “demonstrates that credible YCC policy can be more sustainable for central banks than a quantity-based asset purchase program.”4. The effectiveness of such a policy changes from country to country. There are many factors that must be considered if such a policy will be effective such as the level of spending and the debt burden in a country.