Financial Stocks and Flows in the Time of Covid-19

Main points

• This paper examines the economic effects of the Covid-19 shock and the various policy responses that were put in place in the UK.
• The lockdown led to large falls in output, consumption and investment.
• The Job Retention Scheme helped maintain employment through the lockdown.
• The increases in government spending and the additional Quantitative Easing helped support consumption, investment and output.
• The various loan schemes put in place, as well as the cut in the Bank rate, enabled firms to borrow at low interest rates to tide them through the lockdowns.

In this paper we examine the economic effects of the Covid-19 shock in the United Kingdom and the various policy responses that were put in place.  We do this through the lens of a ‘stock-flow consistent’ model in which financial flows between the various sectors, and the effects of these flows on the stocks of financial assets and liabilities, are carefully tracked.  We find that the lockdown, imposed in response to the Covid-19 outbreak, led to large falls in consumption, investment, output and employment together with a rise in inflation.  The increase in non-performing loans associated with the lockdown led to a fall in bank capital, which, in turn, led to rises in bank lending rates, as banks sought to bring their capital back to target, and falls in bank lending.  We find that the Job Retention Scheme went some way to maintaining employment through the lockdown;  the increases in government spending and the additional Quantitative Easing carried out by the Bank of England (to the extent this led to a fall in bond rates) helped support consumption, investment and output;  the Coronavirus Business Interruption Loan Scheme and the Coronavirus Large Business Interruption Loan Scheme, by underwriting a proportion of the non-performing loans, greatly reduced the rise in bank lending rates;  and that the cut in the Bank rate also helped keep lending rates lower than they would have been otherwise.