Covid-19 pathway towards unconventional policies

The more prolonged the pandemic is, the more strain these measures will put on public balance sheets.

Bank Indonesia has significantly stepped up its fiscal support over the past few months — from purchasing government bonds in the secondary market to direct debt monetisation, and most recently to sharing the interest rate burden of the Covid-19 stimulus package.

A narrowing 'quality' gapImportantly, the Chinese yuan has been broadly stable throughout the pandemic.

China's policymakers have eased less aggressively than their US and Asian counterparts, and the former's financial account remains quite carefully managed, reducing the global spillover effects of Chinese monetary policy.

The region's monetary policymakers will continue to take their cues from the Federal Reserve rather than the People's Bank of China in the foreseeable future, but China's economic and market stability has acted as a crucial stabiliser for the region.

On some levels, the risk profile between emerging Asia and advanced markets is also narrowing.

Political risk is very much an affliction of emerging markets as well as developed markets.

Given the acute polarisation of the American electorate, US domestic politics have become more volatile than at any one time in recent memory.

Institutional risk is now prevalent in developed markets, as suggested by the deficient response of some advanced economies, including the US and UK, to the pandemic. This is in contrast to the generally credible response across much of Asia.

Finally, policy independence used to be a concern primarily in emerging markets. But it is in developed markets where the lines between fiscal and monetary policy have become most blurred in the last two crises.

Policy making in the post-Covid worldAs more economies emerge from their lockdowns, there is an active debate over the shape and size of future spending.

Despite their apparent efficacy as a near-term stabilisation tool, the widespread and rapid deployment of unconventional policies presents some risks once the Covid-19 crisis subsides.

Weaning economies off their extraordinary monetary and fiscal accommodation will be the next big challenge, going by the experience of advanced economies in the aftermath of the Global Financial Crisis.

Productivity and economic growth will still be the surest way out of the crisis, The debt build-up will otherwise be unsustainable for emerging economies, and could lead to stagflation in advanced economies.

The combination of large-scale fiscal and monetary easing in response to Covid-19 could also presage further forays into unconventional policy in response to future economic shocks, potentially including applications of Modern Monetary Theory (MMT).

MMT holds that countries issuing debt in their own currencies cannot default on their (local currency) sovereign debt because central banks can always backstop their governments, if necessary. MMT supporters claim fiscal policy should be the primary cyclical stabiliser of the economy because it has a more direct impact on economic activity with fewer negative side-effects than monetary policy.

Some aspects of MMT remain quite controversial, and hence the probability of its pure application is low, but it is likely to be discussed with increasing frequency.

This article first appeared in the New Zealand Herald