Navigating The Storm: Lessons From Monetary And Fiscal Policy During COVID-19

In a keynote address at the Citi Australia & New Zealand Investment Conference, Reserve Bank of New Zealand Chief Economist Paul Conway reflected on lessons learned from monetary and fiscal policy during the COVID-19 pandemic.

Mr Conway emphasised that in normal times, monetary and fiscal policies can pursue their respective objectives, while maintaining economic stability. But in a crisis, the objectives of monetary and fiscal policies may align in an ‘all hands on deck’ effort to steady financial markets, economic activity, employment, and inflation.

“COVID-19 gave us a crash course on how monetary and fiscal policy can interact in times of extreme economic turbulence. It’s important that we learn from that and carry these lessons forward to be ready for the next major shock. All crisis-era monetary and fiscal policies have their costs and benefits. The more we understand these, the better equipped we will be to successfully navigate the next crisis,” Mr Conway said.

New research released alongside the speech assesses the wider costs and benefits of Large-Scale Asset Purchases (LSAPs), which were the primary tool used to deliver additional monetary policy stimulus.

“Our work to date shows that LSAPs stabilised volatile financial markets and helped prevent inflation from undershooting the target midpoint,” Mr Conway said.

“By supporting broader economic activity, LSAPs also contributed to higher government tax revenue. Indeed, the additional government revenue generated by LSAPs largely offset their direct costs.”

Mr Conway added that “while certainly not perfect, LSAPs need to remain a key part of our additional policy toolkit for targeted interventions during financial and economic crisis when the Official Cash Rate has reached its lower limit.”

Mr Conway also highlighted that often there is not necessarily a single ‘silver bullet’ for managing crises. “Each shock is unique and a flexible, situation-specific mix of monetary and fiscal measures could well be essential.”

This highlights the importance of the monetary and fiscal authorities working alongside each other in an economic crisis. Importantly, this does not imply joint decision making. Even in a crisis, independent monetary policy is essential to keep inflation expectations anchored and central bank credibility intact.

“By carrying forward the lessons of the pandemic, we can ensure New Zealand remains prepared for whatever economic shock lies ahead,” Mr Conway concluded.

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