7 PM Editorial |Providing Right Stimulus in Times of COVID 19| 12th June 2020

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Providing Right Stimulus in Times of COVID 19


To tackle the economic fallout of COVID 19, governments across the world have announced monetary and fiscal incentives accounting to about 10% of global GDP. India too announced ‘Atmanirbhar Abhiyan’ to revive the economy.

But UN Department of Economic and Social Affairs assessed that these measures may not boost consumption and investment as estimated. These measures instead are leading LIQUIDITY TRAP which is hoarding money as capital buffers in anticipation of low future economic activity.

Nature of fiscal measures announced and limitations with them:

Current fiscal and monetary measures aim to boost liquidity. Such monetary measures include reduced repo rates, Open market operations. Fiscal measures include credit availability to MSME’s, credit guarantees, welfare transfers to individuals(Garib Kalyan Yojana) etc. Both try to increase money in the hands of consumers and investors to boost consumption and investment. This is needed in the short term considering the liquidity crisis of companies. Without it bankruptcies, erosion of capital with companies would happen which prevents economic recovery.

Yet this is leading to a liquidity trap where people are hoarding money. Experts predict COVID 19 will last for longer term with estimates upto 2 years. Considering this uncertainty, individuals and companies are preferring to hold cash as precaution rather than spending. Much of the money that households and businesses receive in the form of stimulus will probably sit idle in their bank accounts, owing to anxieties about the future and a broader reduction in spending opportunities.This prevents economic recovery.

At the same time, banks will not lend much due to lack of creditworthy borrowers. This leads to banks having excess reserves(capital beyond reserve requirements). This is already seen in US where excess reserves doubled from february to april. Hence we see low multiplier effect due to current stimulus[Money multiplier = M3/M0= stock of money supply/ stock of high powered money]

In addition, excess liquidity may lead to banks investing in financial speculation. This can result in volatile stock markets and erosion of wealth. This will further increase precautionary behaviour by reducing consumption and investment.

Hence current measures will lead to increase in supply of money but limited use by individuals and businesses. Till the time COVID 19 is under control such liquidity trap will continue unless right stimulus is provided.

Providing ‘Right stimulus’ to kickstart economy:

Role of government becomes important in such a situation to break this vicious cycle. Government must insure against risks for individuals and businesses through compensation. This can nudge consumption and investment and thereby revive economic growth.

Measures which can boost consumption and investment:

  1. Arrow-Debreu securities: These securities are payable if certain conditions are met. Example is suspending monthly car payments for new cars, if COVID outbreak is not controlled to certain extent in certain time.
  2. Income contingent loans and mortgages to boost consumption of consumer durables and real estate.
  3. Issuing spending vouchers with limited validity to households. Limited validity prevents hoarding. China is issuing digital vouchers to buy various goods and services.
  4. Based on the condition of retention of workers, government can subsidize wage payments and other costs, in proportion to reduced revenue. US is mulling such measures.

Poorly designed stimulus will be ineffective and potentially dangerous. At the same time, right stimulus will save businesses and livelihoods by boosting consumption and demand. Hence careful design of stimulus keeping in mind long term prospects is needed to revive the economy.

Source – www.business-standard.com

Mains Question:
  1. Increasing liquidity through fiscal and monetary measures can revive the economy post COVID pandemic. Critically discuss? [15 marks, 250 words]


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