The policy response to Coronavirus: theory and application

In order to guard against and mitigate the potential economic impacts of the pandemic, different policies have been implemented by the UK government and the Bank of England. In this report we aim to look at the rationale behind the implementation of both fiscal and monetary policies and what the potential consequences would have been in their absence. We look at three main levers: conventional monetary policy, unconventional monetary policy and fiscal policy. For each we review the theory before setting this into context. There have been constraints on policymakers’ ability to implement some of these levers due to the macroeconomic situation prior to the pandemic, particularly with respect to conventional monetary policy where interest rates were already close to their effective lower bound. Unconventional monetary policy has continued in the form of quantitative easing, with some new tools being used during this pandemic and hints that so far unused methods, such as negative interest rates, are being considered. Fiscal policy has been where the most inventive and far-reaching policies have been found, with extremely high expenditure permitted by very low borrowing rates faced by government, partly itself enabled by the supportive actions of the Bank of England. This article describes some of the key policy changes that we have seen over the past year and attempts to provide a good basis to understand the rationale for the policy choices, underpinned by economic theory. This article does not gauge success (or otherwise) of specific policies but is intended as a record of events with explanations of the reasoning behind them.