How to cope with recession when the interests are low?
It is hardly a pleasant situation, but it is realistic no less. So, imagine it has happened: oil prices have risen to their critical level, the market is panicking or even paralyzed with fear. The governments have noticed the danger far too late and an extremely strong wave of recession is inevitable. In this situation, central banks are no-brainer to take the following step first: they will decrease interest rates to encourage lending and investment. However, with this approach, the rates are going to reach zero sooner or later, which again can provoke a new wave of recession.
Thus, world governments will use standard anti-crisis tools (e.g. so-called quantitative easing – a measure aimed at printing new money to buy bonds). Yet they will not be as efficient anymore. Bond purchases, for instance, are of little use when the markets are not devalued by the crisis while the long-term interest rates are already low. Under these conditions, non-conventional solutions will be more useful.
Adoption of monetary stimulus will help to solve the recession issue in view of low interest rates. That is what experts from the Federal Reserve System (an independent agency in the USA that functions as the central bank) think. They say that central banks should establish target prices temporarily, which should stabilize the inflation. If the recession causes the inflation rates to remain below the target level, then the central banks will have to artificially raise them over the target level and retain them until the world prices reach their level prior to the economic downfall.
Experts say that such measures would stimulate costs and ensure the overall recovery of the economy. Moreover, raising the target level of inflation would slow down the fall in interest rates.
However, this method has some drawbacks. For example, it is not clear whether banks will be able to support inflation rates at the level needed. Besides, in order to implement this strategy, one would require certain support from other market participants. If the market participants question the central bank’s capabilities and refuse to cooperate, it will take a long time to get the positive results.
Another scenario to fight recession developed by the IMF (International Monetary Fund) experts, Olivier Blanchard and Lawrence Summers, proposes using fiscal policy methods.
The fiscal policy itself is a tool to fight the recession. Yet in conditions that are still far from the crisis ones, it does not always lead to a measurable result. And if we deal with a deep downturn in the economy continuing at zero interest rates, then the fiscal stimulus can become an excellent trump. But on a condition that banks remain loyal to the markets and do not “tighten the screws” in fear of the crisis.
Ideally, in order to resolve the crisis situation, one should use the instruments of monetary and fiscal policies at the same time – say the experts. However, such approach can lead to an excessive politicization of the central banks and loss of their autonomy. Economists differ in their assessments of this outcome. For example, Olivier Blanchard fears that the government interference in the central bank during the crisis will be insufficient, but it will become much robust and painful once the situation is stabilized.
Most other economists, on the other hand, are afraid of something else. They think that the government will use too many monetary incentives to stabilize the inflation rate.
This post is also available in: Russian