Pandemic Recession Dynamics: The Role of Monetary Policy in Shifting a U-Shaped Recession to a V-Shaped Rebound

Abstract:

COVID-19 has depressed economic activity around the world. The initial contraction may be amplified by the limited space for conventional monetary policy actions to support recovery implied by the low level of nominal interest rates recently. Model simulations assuming an initial contraction in output of 10 percent suggest several policy lessons. Adverse effects of constrained monetary policy space are large, changing a V-shaped rebound into a deep U-shaped recession absent large-scale Quantitative Easing (QE). Additionally, the medium-term scarring on economic potential can be large, & mitigation of such effects involves persistently accommodative monetary policy to support investment & long-run productive capacity. The simulations also illustrate the importance of coordinating QE & interest rate policy. Finally, the simulations, conducted within a model developed prior to the pandemic, illustrate limitations in economists’ understanding of QE & the channels through which shocks like a pandemic affect medium-term economic performance.

DOI: https://doi.org/10.17016/FEDS.2020.083

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Last Update:
October 07, 2020

Source: Federal Reserves

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