Policy challenges
Challenges in advanced economies
In the immediate term, strengthened infection control
policies in advanced economies, including effective
surveillance and universal masking, have the
potential to significantly alter the pandemic’s course
and bolster the recovery. As the crisis abates, policy
makers will need to keep policy support in place to
sustain the recovery, despite the sharp rise in debt
levels, gradually shifting from income support toward
growth-enhancing policies. With limited scope for
further central bank support, policy makers will also
need to consider a greater role for fiscal policy in
bolstering activity. In the long run, structural reforms
are needed to reverse economic scarring from the
pandemic and stimulate productivity growth,
including by facilitating sectoral reallocation,
harnessing digital technologies, and tackling rising
inequality.
Monetary and financial policies
The COVID-19 pandemic will likely contribute
to the trend decline in real interest rates (Jordà,
Singh, and Taylor 2020). Nominal short rates will
likely remain near zero for years, leading to an
extended period of markedly negative real interest
rates as central banks shift from crisis management
to supporting the recovery (figure 1.18.A;
Henneberg and Mann 2020).
Given the growing reliance on unconventional
policy tools, some major central banks have
considered alternative policy regimes. For
instance, the U.S. Federal Reserve has adopted
average inflation targeting, under which inflation
will be allowed to rise above target to compensate
for the undershooting during downturns (Powell
2020). The anticipation of the new approach has
contributed to a modest rise in market-based
inflation expectations (figure 1.18.B).
Due to the severe adverse impact of COVID-19
on aggregate demand, inflation risks are squarely
to the downside in the near term. That said, a
sizable part of the pandemic’s macroeconomic
impact was in the form of a supply shock (Brinca,
Duarte, and Faria e Castro 2020). If policy efforts
are unable to reverse supply-side damage, inflation
may resume at a faster than expected pace in the
medium-term, prompting unexpected policy
tightening.
Financial authorities have generally responded to
COVID-19 by using the flexibility of regulatory
standards,
supporting
affected
borrowers,
promoting balance sheet transparency, and
maintaining operational and business continuity
of banks. These measures have helped to maintain
the flow of credit and mitigated financial sector
stress (Nier and Olafsson 2020; IMF and World
Bank 2020). Once the pandemic is effectively
contained, these measures would need to be
gradually tightened or reversed to guard against a
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