The coronavirus outbreak has brought the global
economy to a halt like we’ve never seen before.
With a global health emergency
sitting at the center of the crisis,
every sector of activity has been affected
with unemployment soaring and economies shrinking.
A recession of this scale has policymakers worldwide
stepping up as they attempt to prevent the worst.
Central banks were some of the first to step in,
but has their approach been effective?
Just over a decade ago, the world was
grappling with the global financial crisis.
Central banks, known as the lenders of last resort,
came into the spotlight like they’d never been before.
They took several measures to prevent
the Great Recession from turning into a depression.
And one of the first steps they took
was lowering interest rates to rock-bottom levels.
So what is a central bank trying to achieve
when it lowers rates?
The interest rate is what central banks
charge other lenders for short-term borrowing.
This, in turn, affects how much interest consumers
pay on their loans and earn on their savings.
If rates are low, people and businesses
can take advantage of cheaper loans,
which in turn should boost the economy
as they spend more on goods and services
or invest in improving productivity.
However, real interest rates,
which take inflation into account,
have been at historic lows since 2009
and have never rebounded
despite a decade of economic expansion.
There are a variety of factors that limit the ability
of central banks to affect real interest rates.
These include low productivity levels, a surplus
of global savings and economic growth prospects.
As the coronavirus pandemic started
spreading outside China,
a flurry of central bank announcements followed.
The U.S. Federal Reserve was the first to
surprise markets with an emergency cut
to interest rates in early March,
and it followed with a second cut later that month.
With the two separate announcements,
the central bank brought its funds rate down
to the range of 0% to 0.25%, a level first reached
during the global financial crisis of 2008.
The committee judged that the risks
to the U.S. outlook have changed materially.
In response, we have eased the stance of monetary
policy to provide some more support to the economy.
Hot on the heels of the Fed cut,
other central banks also slashed their interest rates,
including major players such as
The Bank of England, The Bank of Canada,
the Reserve Bank of New Zealand
and the Bank of Korea.
As the global economy went into a tailspin,
these institutions all agreed to cut rates
as part of a coordinated effort to limit the damage
caused by the coronavirus outbreak.
So, can low rates save our economies from
crisis?
The coronavirus is a new kind of economic shock.
Unlike the 2008 financial crisis,
the virus is first and foremost a health issue,
not something that emerged from financial institutions.
Many economists, therefore, argue that cheaper loans
won’t solve the coronavirus crisis.
With around a third of the world’s population
under lockdown,
enabling people to spend more is not going to
help much since they are all stuck at home.
And besides, restaurants, cinemas,
and shops are closed
which means consumers have far fewer ways
to spend their money.
Fears of a deepening recession
have also dented investor confidence
amid a global rout on the stock market.
Which is why some experts have
raised the following question:
have central banks reached
the limits of their arsenal?
These institutions have tested new
and unconventional tools over the last decade,
including negative interest rates
and cash handouts.
In places such as the euro zone and Japan,
central bankers have cut rates so low
that they have even gone below zero.
This means that financial institutions are
getting paid to borrow cash and
penalized for keeping excess reserves.
But arguably, this has also proven ineffective.
Japan has had negative rates since 2016,
but the world’s third largest economy has
been struggling with a stagnant economy
and very low inflation for years.
It’s a similar situation in the euro zone,
where the European Central Bank lowered rates
into negative territory in 2014, and there is no clear
timeline for them to revert to normal levels.
Low, or even negative rates, have been a feature
of the economic landscape for the last decade.
With the ongoing health and financial crisis
showing no signs of going away,
central banks are running out of tricks
to mitigate the fallout.
More broadly, there is a general consensus
that no rate cut, or government funding
will end the ongoing economic crisis,
at least not until the core issue is solved.
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