In my last post I noted that the “supply or demand shock” framing for COVID-19 could be useful, but hid important elements – namely even when there is a real shock if we aren’t noticing rising factor prices (eg wages) there is a demand element.
Given current concerns most focus is on the question of how to deal with the consequences of a disaster now – in a way that doesn’t lower productive capacity in the future. This is a good frame, and the New Zealand discussion has been strong relative to a lot of other countries.
However, even though a lot of the stores are closed now “demand” management is not just about that future – it needs to occur now as well. As a result, monetary policy does have a role.
If the shops are closed how can demand management matter?
Closed shops due to COVID are a supply shock, as the price of the things they sell has essentially shot to infinity. But that isn’t the only effect.
Because in so far as resources can “transfer” into a better use during the crisis we want them to, this helps to reduce the fall in output, prevent hardships, and support businesses. It is important to find ways to improve outcomes from these issues directly given that it is a “large temporary (but persistent) supply shock [eg business continuity loans, hardship payments, and employment protection] but demand policies – such as cuts to the official cash rate at QE – help with that transition.
In this way, let’s get back to the nominal income (or NGDP targeting) idea. I have outlined this in two posts here and here. In the second I noted that it gives people incentives to invest and take on actions knowing that, if they make a reasonable choice, they will experience a given increase in their nominal incomes. This helps to support necessary transitions.
Similarly, Ben Bernanke proposed an idea of temporary price level targeting, which recommends central banks keep rates ‘lower for longer’ . Bernanke believes it can help reduce longer-term rates and encourage spending today because of reduced expectations of future short-term interest rates and because of raising expected future inflation.
As a result, even if the unconventional monetary policy actions seem spent, and fiscal authorities do not want to bear further debt or risk, there remains a chance for central banks to promote level targeting. And, unlike many other tools, level targeting appears extremely appropriate for dealing with a temporary but persistent supply shock – as it helps deal with coordination coming out of the shock given the certainty about nominal income or prices (depending on the target used).
It is too easy to say “this is a supply shock, we can do nothing” or “this is a temporary uninsurable supply shock, so the only thing that must be done is subsidies and loans”. However, in a world with remote work and delivery, and an ability to substitute even service work to be done from distance, there is real potential for demand management to help keep businesses working and people employed as a complement to such supply policies.