For a healthy recovery period after a crisis, government or Central Bank interventions are essential. These interventions soften the impacts of economic fluctuations. We mainly have two regulatory policies: Fiscal Policy and Monetary Policy. Many governments have already started to apply one or both of these policies. We will first analyze the fiscal responses along with its advantages and disadvantages.
The Purpose Of Fiscal Policy
Fiscal policy is an approach by the government, in which the taxation rates, government spendings, and transfer payments are changed to influence the aggregate demand. During a drastic decrease in the aggregate demand, pursuing an expansionary fiscal policy through increasing the government spendings or lowering the taxation rates encourages people to consume more, which increases the aggregate demand. Even though the priority of fiscal policy is usually to support the aggregate demand as stated, this crisis is not solely influenced by the demand shock. The aggregate supply is severely affected as well.
Why Must Demand Be Permitted To Decline?
According to Professor Olivier Jean Blanchard, Senior Fellow at the Peterson Institute for International Economics, “as long as lockdown is in effect, demand must also be permitted to decline;” this is mainly because since the output in many industries are very low due to constraints like lockdowns, a policy such as tax cuts would “sustain demand over output” and lead to inflation1. Thus, according to Professor Blanchard, for committing to a fiscal expansionary policy, the government should wait to see the situation of the aggregate demand after the restrictions are relaxed. Our priority with the fiscal policy, specifically the government spending, must be giving incentives to firms to produce vaccines and tests along with giving disaster relief to help people and businesses affected by the crisis1.
Individual Fiscal Policies, And Is It Sufficient?
In terms of rapid fiscal responses, the UK, US, Australia, and Nigeria were the first countries to approve large federal stimulus packages for industries and businesses affected by the pandemic. Australia, US, UK, and India also approved large social welfare payments or provisions of income supports2. Many countries later implemented similar policies.
Fiscal policy alone cannot recover the economy. This recession is different compared to many of the previous crises as the industry output is very low in many sectors while we also experience a concurrent demand shock. Thus, for recovering the aggregate demand through fiscal policies, we first need to recover the production. Right now, before we can recover the production, fiscal policy will be helpful to soften the impacts of the crisis on businesses and households through social relief packages. A full recovery mainly depends on measures to eliminate COVID-19 and measures to prevent a second wave.
You can read a more detailed article about post-pandemic economy via this link.
You can read the policy responses of each country via this link. https://www.imf.org/en/Topics/imf-and-covid19/Policy-Responses-to-COVID-19#U