Press Release: Covid-19 crisis - Fiscal policy should lead and the Bank of England should follow for the duration of the crisis

Published: 26th March 2020

The enormous economic shock of the Covid-19 strain of the Coronavirus has introduced radical uncertainty, as we do not know that much about its incidence or duration. It is likely to be a temporary shock and, as it does directly result from monetary-fiscal-regulatory laxity, it is not subject to the typical problems of moral hazard when designing a policy response.   
The main response should be large-scale temporary fiscal support. This must be supported by a “whatever it takes” approach by the Bank of England to ensure as little damage as possible to long run capacity. But a huge question on the exit strategy from what might be extraordinary monetary accommodations will loom large.   
A paper by three leading economists and published by the National Institute of Economic and Social Research (NIESR) says that the Covid-19 crisis has exposed several fissures in current monetary policy practice. They praise the actions taken last week by Chancellor Rishi Sunak and Bank Governor Andrew Bailey, but say that they now need to take more radical steps to ensure that financial stability is maintained once the pandemic has passed. 
In their report, ‘Monetary Policy in Troubled Times: New Governor...New Agenda’, Jagjit Chadha, NIESR’s Director, Richard Barwell, Head of Macro Research at BNP Paribas Asset Management, and Michael Grady, Head of Investment Strategy and Chief Economist at Aviva Investors, say that the UK monetary authorities have an opportunity to undertake radical policy reforms that will increase the space for monetary policy. 

They say that with the unprecedented nature of the Covid-19 crisis, and the possibility of severe economic disruption, central banks will need to find all the ammunition they can to support demand in the economy. They find: 

  • The Bank has now exhausted almost all of the conventional monetary space that existed before the pandemic struck. There is still some scope to stimulate demand through further purchases of public and private sector assets, credible commitments to purse a "low for too long" strategy in the future and cutting rates into negative territory. 
  • Even if the Bank does all of the above it will probably not be enough, so more formal monetary support of the fiscal response will be required.  The prudent course of action is yield curve control, where the Bank can create and preserve fiscal space for the Chancellor whilst still retaining its operational independence, although if tested this regime may mutate into monetary financing. 
  • When the crisis is over, the Chancellor and Governor must revisit the monetary framework. The perception that the central bank balance sheet is the answer to every economic problem has gone unchallenged for too long and the response in this crisis might reinforce that view.   
  • Clear rules need to be established around the operations of the Bank, which has become "the only game in town", to ensure that it can re-focus on the narrow pursuit of monetary and financial stability.  The question of raising the inflation target to restore monetary space cannot be ducked any longer.  It would be a mistake to take this decision and others about operating procedures at a time of national crisis, for fear that the Chancellor's motives are misunderstood. But it would be pure folly to leave the Bank so ill-equipped to fight future crises. 

Director of NIESR, Professor Chadha said: “The rapid, global spread of the coronavirus has triggered an economic shock that resembles that of the financial crisis some dozen years ago. What we need to do here is consider more radical steps but ones that will still ensure the adherence to monetary stability once this crisis has passed. 
“However, co-ordination of monetary and fiscal policies is blurring the role of the central bank as the guarantor of monetary stability. The key here will be how to emerge from this crisis and ensure that the bread and butter objectives of monetary and financial policy remain intact. The best answer of all might be for the Governor to call for an external Review of the Bank’s Remit and Objectives and use that to refocus on the bread and butter of central banking in the long run while managing the crisis in whatever it takes mode until then.” 



Notes for editors:   

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