Monetary policy
penalized for having excess liquidity, they’re less likely to build up any form of liquidity reserve. The lack of excess liquidity jeopardizes their financial security if any downturn happens. Furthermore, NIRP can lead to lower profitability for banks as net interest margins (NIM) contract (NIM is a measure of the difference between banks cost of borrowing and lending). This ultimately means that it can adversely impact the overall health of the financial system. Expansionary monetary policy is not the only way the state can create additional money balances; they can also use expansionary fiscal policy. Fiscal policy is the use of government revenue collection and expenditure to influence a country’s economy. It can increase AD as government expenditure would increase, thereby increasing the money supply. Unlike monetary policies, fiscal policies have relatively shorter time lags and can be directed towards specific sectors or projects. In addition, if the government allocated its expenditure towards public work investment schemes, it could start a multiplier effect where households gain wages and further stimulate private sector investment. This would further boost the AD level, increasing the money supply further. The two types of expansionary fiscal policy are government expenditure and tax cuts. Government expenditure can come in many forms such as subsidies, grants and funding. In the UK in response to the high levels of unemployment due to Covid-19, the government introduced a furlough scheme. The scheme provides people who have been furloughed by their employers with 80% of their wages with a £2,500 cap per month. As well as this in August 2020 another major fiscal policy was introduced, ‘the eat out to help out scheme’. This scheme encourage d people to eat out on Monday, Tuesday and Wednesday which are traditionally quiet nights for restaurants by offering 50% off per head for a maximum of £10. What if expansionary fiscal policies are implemented for a prolonged period of time? If the economy is near full capacity expansionary fiscal policies are likely to contribute to higher inflation levels without seeing much of an increase in real GDP. 2 They can also create unsustainable debt dynamics that can be detrimental for longer-term growth. 3 This is when a government is spending more money annually than it takes in. A study by World Bank found that if the debt-to-GDP ratio of a country exceeds 77% for a prolonged period of time it can slow economic growth because of a higher risk of default. This is the complete opposite of the intended effect of expansionary fiscal policy. The fact that this debt will eventually need to be paid off must be accounted for as well. The debt will be paid back in the future through tax increases and government expenditure cuts. If the government’s attempt to increase revenue in the future is too aggressive it can cause another downturn in economic growth. We can see from the above analysis that both fiscal and monetary policies each have their own advantages and disadvantages. Neither one in isolation represents an adequate approach. However, what we can state with confidence is that monetary policy is not exhausted. At the Jackson Hole Economic Policy Symposium (28 August 2020), BOE’s Governor Bailey 4 discussed the future prospects 2 Impact of Expansionary Fiscal Policy ; Tejvan Pettinger; 25 th July 2019. 3 The primary budget balance, defined as the budget balance net of interest payments, is a key determinant of government debt dynamics. Stabilizing the government debt-to-GDP ratio and subsequently putting it on a declining path towards the reference value requires a sufficiently large primary surplus to be generated over an extended period of time if the interest rate-growth differential is positive, as conventionally assumed. Government debt dynamics and primary budget balance developments in the EUmember states ; Monthly Bulletin; March 2011: 95. 4 The central bank balance sheet as a policy tool: past, present and future ; Andrew Bailey; 28 th August 2020; 6
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