Low inflation gives scope for major stimulus to address coronavirus pandemic
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Low inflation gives scope for major stimulus to address coronavirus pandemic

Credit Suisse's chief European economist Neville Hill examines central banks' response to pandemic-triggered turmoil.

The effects of the COVID-19 have cascaded through financial markets and the global economy, leading to steep declines in equity markets and the cancellation of major business, entertainment and sporting events.

In Credit Suisse' s latest podcast, senior advisor Brian Blackstone and Credit Suisse' s chief European economist Neville Hill discuss the aggressive response by central banks around the world, and why ultra-low inflation is giving them the flexibility to act.

Low inflation "gives central banks considerable headroom to ease monetary policy," Hill said. On Sunday, March 15, the Federal Reserve lowered its policy rate to nearly zero and launched a USD 700 billion bond program. Central banks in the eurozone, UK, Sweden, and elsewhere have also eased policy.

A key task of most central banks is to keep inflation low and stable, with many targeting 2 percent annual consumer-price growth as optimal. When it is well below that rate – as it is now or may be soon in most developed economies – central banks can ease policy dramatically through interest rate cuts, asset purchases and other measures to address economic fears without triggering an outbreak of inflation.

Critically, the short-term effect of the coronavirus will likely be for inflation to fall even further as the steep drop in oil prices funnels into reduced prices for petrol and other types of energy. That would be good news for consumers.

But there is a distinction between declining prices in some categories like petrol stations – which raise consumers' disposable incomes – and persistently falling prices across the board, known as deflation, that may lead to wage cuts that make it hard for households to service debt. To guard against this risk, Hill sees scope for further stimulus from central banks particularly in the form of asset purchases.

However, governments must play an active role too with their tax and spending policies.

"Ultimately, a lot of the hard work is going to have to be done by fiscal policy," Hill said.