Covid-19 Stress - Falling GDP, Central Banks, What else?

The severity of the impact of Covid-19 on world economy is unprecedented. It has exposed the fault lines that already existed in the global economy prior to the pandemic. Slowing global economy, lack of reforms, poor fiscal discipline & US-China trade tensions cannot be entirely masked by the black-swan event.

Of note, the US Fed with all its might (monetary policy ammunition) has not been able to instill confidence in the economy and stop the large-scale (ongoing) disruption in economic activity. The 2008 financial crisis had demonstrated to the world that conventional monetary policy tools (like lowering interest rates etc) were insufficient to shore up the flagging economy. Thus, the Fed went ahead with large scale asset purchases (popularly known as Quantitative Easing). The fed has tried to follow a similar playbook this time around as well. It can be easily identified from the below graph that after trying to normalize the balance sheet for a brief period in 2018-2019, the Fed again started expanding its balance sheet when it saw the signs of a slowing US economy. With the onset of Covid-19 and its visible economic impact (due to strict lockdowns & rising infection cases), the Fed pull out all stops to beef up the US economy. This can be seen from the scale of asset purchases done by Fed in 2020 (compare them with the one in 2008 Financial Crisis).

Notably, in the below chart, we can see that even unprecedented increase in levels of money supply (M2) has not been able to stop the fall in real GDP yet.

Interestingly, the Fed is also not ready to stop this time around until it achieves its target of an average 2% inflation (relaxed from targeting a fixed inflation of 2%). However, the extent of damage is far greater than the 2008 financial crisis in terms of decline in real GDP (and job losses). Time will tell us if the the use of unconventional policy (by Fed & other central banks) will work or if it has lost its steam.

As per my understanding of the situation, sole reliance on the monetary policy tools (conventional or unconventional) will not be sufficient to bail the world economy out of the hole this time around. The world will need some out of the box fiscal (& reformist) thinking & astute leadership to come back on the financial growth path.