Consider the Following Statement by Pierre-Olivier Gourinchas: Monetary Economics Assignment, TCD,

Question 1

(a) Consider the following statement by Pierre-Olivier Gourinchas: “To see this, assume that, relative to a baseline, containment measures reduce economic activity by 50% for one month and 25% for another month, after which the economy returns to the baseline…. that scenario would still deliver a massive blow to headline GDP numbers, with a decline in annual output growth of the order of 6.5% relative to the previous year. Extend the 25% shutdown for just another month and the decline in annual output growth (relative to the previous year) reaches almost 10%!”

(“Flattening the pandemic and recession curves”, page 33) Assume an alternative scenario in which the COVID-19 containment measures reduce economic activity by 50% for three months and 25% for another three months, after which the economy returns to the baseline. What would be the decline in the annual growth rate (relative to the previous year) in that scenario? Show all your workings.

(b) Consider the Phillips curve equation that we discussed in class on 23 January 2020:

Do you expect actual inflation in the Euro Area will rise above or fall below target inflation over the next few quarters of 2020 as a result of the COVID-19 crisis? Use the Phillips curve equation above to explain your answer.

Question 2

Consider the following stylised commercial bank’s balance sheet.

(a) Under the so-called Additional Credit Claims (ACC) initiative, the European Central Bank (ECB) may accept pools of secured (including mortgages, residential and commercial) and unsecured credit claims as collateral for Eurosystem credit operations. On 18 March 2020, the Governing Council of the ECB decided to expand the scope of ACC to include claims related to the financing of the corporate sector. If the stylised commercial bank above were to borrow funds from the ECB under the ACC programme, how would the commercial bank’s balance sheet change.

(b) In what ways might we expect the expansion of the scope of the Additional Credit Claims programme to increase the provision of credit to businesses during the COVID-19 crisis?

Question 3

“Government efforts to keep their economies afloat through the coronavirus crisis are likely to cause budget deficits to increase sharply. Given the need for large fiscal deficits, the question arises as to whether central banks should pay for the fiscal stimulus through direct monetary financing, effectively printing money, or should governments borrow from markets in the usual way?”

(a) How might a central bank use monetary financing to allow the government to run up a bigger budget deficit?

(b) What are the advantages and disadvantages from an overall economic perspective of using monetary financing to fund budget deficits as opposed to governments borrowing from markets in the usual way?