Although central banks across the world have played a vital role in easing financial conditions, which has contributed to averting a catastrophic downturn amid the COVID-19 crisis, they have to do more as the crisis continues, the International Monetary Fund (IMF) said.
The IMF noted that more monetary stimulus will be needed to back the economic recovery.
“Even with interest rates very low out the yield curve, inflation remained chronically low and appeared to be pulling down long-run inflation expectations in many economies. This is a concern because it would put downward pressure on nominal yields and further erode policy space,” the IMF said.
In this regard, the IMF said that the COVID-19 crisis has greatly intensified these challenges, as employment has collapsed, threatening a major humanitarian crisis in many economies, and inflation has been further depressed by weak activity and falling commodity prices.
The blog suggested that the purchasing of sovereign bonds or corporate debt in a more aggressive way, combined with new approaches, can play a critical role in accelerating the recovery from COVID-19 process, as well as from the likely future shocks that could hit economies.
However, the IMF warned that these more accommodative policies may place substantial risks down the road by encouraging excessive risk-taking and a build-up of vulnerabilities.
On the other hand, central banks need to adopt macroprudential policies that serve as the first line of defence in alleviating financial stability risks, consistent with the IMF’s policy advice. In addition, monetary policymakers should incorporate macro-financial stability considerations in their decision making, besides the path of output, unemployment, and inflation.
Suggesting a “New Keynesian” modelling framework, financial counsellor and director of the IMF’s Monetary and Capital Markets Department Tobias Adrian said that it allows central banks to quantify the trade-off between boosting inflation and output in the near-term and increasing financial stability risks down the road.
“According to the framework, easy monetary policy stimulates aggregate demand not only through standard channels, but also through a risk-taking mechanism. Looser monetary policy today relaxes financial conditions and reduces near-term risks to both output and financial stability, but also cause financial fragilities to grow over time, increasing output risk in the medium term,” said Adrian
He added that the framework is designed to help policymakers balance the intemporal trade-off associated with “low-for-long” monetary policies, including those deployed in response to COVID-19.
