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Bold action from central banks – such as the ECB’s €750m bond buying programme covering both sovereign and corporate debt – has been the monetary policy response. But with interest rates already at historically low levels, that particular tool in the armoury is of limited effectiveness. The problem, noted Deutsche Bank’s market strategists Oliver Harvey and Robin Winckler on 20 March, is not one of demand shock but rather supply shock that is now spilling over into demand.
“Consumers did not initially stay away from shops and restaurants because they were worried about their future economic prospects, but because governments told them to stay at home,” they reflect. “Holidays are not being cancelled to shore up household finances but because countries have closed their borders. Workers have not been furloughed from factories because of insufficient orders, but because employers are worried about the risk of spreading disease.”
The point is that the mass unemployment caused by such measures will result in a dramatic drop in aggregate demand. At the same time the fiscal responses of the various stimulus packages coming from governments could, they note, drive up inflation, while not being particularly effective. Vast economic stimulus is unlikely to boost demand in these sectors as long as the pandemic ravages, Harvey and Winkler reflect.
They continue, “If the government tries to keep spending at levels before lockdowns began, while at the same time keeping lockdowns in place, there will be simply more money chasing after significantly fewer goods and services. The result of this will be inflation, and a lot of it.”
But overall, they don’t believe the risk of “runaway inflation that would warrant a flight to pure inflation hedges like gold” to be very high. And despite comparisons with wartime conditions, they conclude “this pandemic is going to have far less of a dent on the productive potential of the economy: our human and physical capital, our technology, and our institutions are going to come through this fairly unscathed”.