Tag Archives: covid-19

Policy in the era of a pandemic

The COVID Pandemic has stretched all the economies around the world to their limits including India. Add to that the fact that the Indian economy was already experiencing a recession kickstarted by demonetization, worsened by GST, and now most likely prolonged by COVID 19. While there is no doubt that increased government spending or fiscal stimulus is the need of the hour, financing it amidst the dismal economic conditions is going to be difficult. At this point there does not seem to be any viable alternative to monetizing the resulting deficit by the RBI and most likely government will take that route.

However, there is no reason for suspension of the Monetary Policy Committee as has been suggested by some. The monetary policy independence and credibility through the establishment and functioning of the MPC over the past couple of years is certainly hard earned. The current crisis should not be used to sacrifice this important institutional innovation despite the disagreement one may have over its narrow mandate of inflation targeting. It will need to decide on policy rates from time to time as the inflationary effects of increased government spending unfold over next few quarters taking into consideration the economic conditions then.

If the RBI monetizes the deficit, it means that it will print money to purchase government debt. This is one of the ways of financing government spending, the other being tax on labor income among others. The benefit of raising revenues by printing money- seignorage- it can be accessed relatively quickly than a labor tax. However, it has the disadvantage of being inflationary if it has kow output elasticity. Besides, the debt subscribed by the RBI to finance the spending has to be serviced and retired later. This can be done by again printing money or raising labor taxes in future. If government keeps on rolling over the debt by printing money, eventually there is the risk of hyper inflation. Therefore, to honor its inter-temporal budget constraint , the only sustainable way for the government to accommodate deficit monetization today, will be to raise labor income taxes in future to pay for the spending today.

The crisis precipitated by COVID 19, however, is a special case. It is essentially a supply shock, where the productive capacities of the economy have been temporarily suspended. Many of such firms will resume business as the lockdown is lifted across India gradually. However, given the nature of production relationships some of these businesses might just close shop as a result of destruction of relationship capital. Moreover, investment spending which already had started falling may not recover so soon because of significant future uncertainty. Therefore, the replacement of destroyed capital and productive relationships by new ones may not happen if left entirely to the private sector. Government spending can certainly help some of these businesses survive or revive as the case might be.

As with any macroeconomic shock, its initial nature does not remain permanent. A supply shock eventually could become a demand shock and vice versa. The current crisis is no exception. With hordes of informal and some formal workers loosing jobs, the COVID crisis is now also a demand one. Informal sector workers as well as firms are cash strapped and direct infusion of liquidity could be the only way to help for now. Such fiscal stimulus could help in a big way alleviating starvation and joblessness. Also, given that many of these workers are also migrant workers, a substantial burden of expenditure will be on the host states which the center needs to finance.

Unfortunately, center state relations have already been stressed because of shortfall in the GST revenues. There are important political economy considerations which are in play. Helping out a state with a non-BJP government may bolster the support for the non-BJP party in that state, while not doing so hampers any chances BJP might have to form state government in future. How and when the central government resolves this tradeoff will depend on how it perceives the probability of it being reelected in the next elections.

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Filed under current economic issues, Monetary Policy

COVID-19 Impact: Some Contrarian Views

Two important questions: How deadly is the virus and what should be the policy response. Two articles that make convincing arguments about deadliness of the virus being overestimated are as follows:

  1. Covid-19 total lockdown: An economic and humanitarian disaster by Rupa Subramanya on orfonline.org
  2. Is the Coronavirus as Deadly as They Say? by By Eran Bendavid and Jay Bhattacharya in the Wall Street Journal.

Both the above articles argue that the actual fatality rate of COVID-19 should be much lower than what is being reported if calculated correctly. The second article is behind a pay wall unfortunately but the crux of the argument is based on the wrong way of fatality rate calculation- should be calculated as percentage of infected population and not as of confirmed cases done by several epidemiological modelers. Here is what they say:

How can we reconcile these estimates with the epidemiological models? First, the test used to identify cases doesn’t catch people who were infected and recovered. Second, testing rates were woefully low for a long time and typically reserved for the severely ill. Together, these facts imply that the confirmed cases are likely orders of magnitude less than the true number of infections. Epidemiological modelers haven’t adequately adapted their estimates to account for these factors.

Given this background, an article by two renowned development economists, Debraj Ray and S Subramnain becomes especially pertinent.

In India’s battle against Covid-19, we are inevitably confronted by the choice between social distancing on the one hand, and denying people their livelihood on the other. Recognising the unsustainability of a general, mandatory lockdown, Ray and Subramanian put forth a proposal whereby the young are legally permitted to work and the locus of measures to avoid intergenerational transmission is shifted to the household.

I am glad that at least the Delhi and Kerala governments are resorting to humanitarian policies like opening food shelters to care for the plight of migrant workers, however, it might be worth deliberating on the policy proposals by Ray and Subramanian above.

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Filed under current economic issues, indian economy, social perspectives