The coronavirus outbreak has brought the global economy to a halt like we’ve never seen before.
With a global health emergency sitting at the center of the crisis,
every sector of activity has been affected with unemployment soaring and economies shrinking.
A recession of this scale has policymakers worldwide stepping up as they attempt to prevent the worst.
Central banks were some of the first to step in, but has their approach been effective?
Just over a decade ago, the world was grappling with the global financial crisis.
Central banks, known as the lenders of last resort, came into the spotlight like they’d never been before.
They took several measures to prevent the Great Recession from turning into a depression.
And one of the first steps they took was lowering interest rates to rock-bottom levels.
So what is a central bank trying to achieve when it lowers rates?
The interest rate is what central banks charge other lenders for short-term borrowing.
This, in turn, affects how much interest consumers pay on their loans and earn on their savings.
If rates are low, people and businesses can take advantage of cheaper loans,
which in turn should boost the economy as they spend more on goods and services
or invest in improving productivity. However, real interest rates,
which take inflation into account, have been at historic lows since 2009
and have never rebounded despite a decade of economic expansion.
There are a variety of factors that limit the ability of central banks to affect real interest rates.
These include low productivity levels, a surplus of global savings and economic growth prospects.
As the coronavirus pandemic started spreading outside China,
a flurry of central bank announcements followed.
The U.S. Federal Reserve was the first to surprise markets with an emergency cut
to interest rates in early March, and it followed with a second cut later that month.
With the two separate announcements, the central bank brought its funds rate down
to the range of 0% to 0.25%, a level first reached during the global financial crisis of 2008.
The committee judged that the risks to the U.S. outlook have changed materially.
In response, we have eased the stance of monetary policy to provide some more support to the economy.
Hot on the heels of the Fed cut, other central banks also slashed their interest rates,
including major players such as The Bank of England, The Bank of Canada,
the Reserve Bank of New Zealand and the Bank of Korea.
As the global economy went into a tailspin, these institutions all agreed to cut rates
as part of a coordinated effort to limit the damage caused by the coronavirus outbreak.
So, can low rates save our economies from crisis?
The coronavirus is a new kind of economic shock. Unlike the 2008 financial crisis,
the virus is first and foremost a health issue, not something that emerged from financial institutions.
Many economists, therefore, argue that cheaper loans won’t solve the coronavirus crisis.
With around a third of the world’s population under lockdown,
enabling people to spend more is not going to help much since they are all stuck at home.
And besides, restaurants, cinemas, and shops are closed
which means consumers have far fewer ways to spend their money.
Fears of a deepening recession have also dented investor confidence
amid a global rout on the stock market.
Which is why some experts have raised the following question:
have central banks reached the limits of their arsenal?
These institutions have tested new and unconventional tools over the last decade,
including negative interest rates and cash handouts.
In places such as the euro zone and Japan, central bankers have cut rates so low
that they have even gone below zero. This means that financial institutions are
getting paid to borrow cash and penalized for keeping excess reserves.
But arguably, this has also proven ineffective.
Japan has had negative rates since 2016, but the world’s third largest economy has
been struggling with a stagnant economy and very low inflation for years.
It’s a similar situation in the euro zone, where the European Central Bank lowered rates
into negative territory in 2014, and there is no clear timeline for them to revert to normal levels.
Low, or even negative rates, have been a feature of the economic landscape for the last decade.
With the ongoing health and financial crisis showing no signs of going away,
central banks are running out of tricks to mitigate the fallout.
More broadly, there is a general consensus that no rate cut, or government funding
will end the ongoing economic crisis, at least not until the core issue is solved.
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