Executive Summary:
The COVID-19 pandemic caused a global economic crisis, resulting swift and dynamic responses from central banks and governments. In this scenario, India’s RBI and Government approach proved far more effective than the US Government stimulus and Interest rate decision taken by FED, despite its resource constraints.
This paper will depict the key policy measures adopted by both nations and their different outcomes to combat and navigating economy in the Pandemic time.
India’s success story lies around the Pradhan Mantri Garib Kalyan Yojana (PMGKAY), a scheme offering free food grains and optimal cash transfers to vulnerable groups instead of giving large cash assistance to the people as US did. This direct food security intervention not only mitigated hunger but also freed up household budgets, indirectly controlling inflation. Additionally, the Emergency Credit Line Guarantee Scheme (ECLGS) supported businesses without distorted by the challenges happened due to Pandemic.

Conversely, the US’s CARES Act Provided Huge cash handouts to the people, leading to asset inflation/bubble and inequalities. The Federal Reserve’s quantitative easing (QE) program further fuelled inflation, creating an unstable economic scenario.

In this paper, we will Discuss how this happened? And what are the inputs that Central banks needed to take from RBI for navigating economies in turbulent times.

Let’s start with the,

What is Quantitative easing?

Quantitative easing (QE) is a technique used by central banks. In India, it’s RBI, to increase the money supply in the Economy and eventually encourages lending and investment. In Simple words, QE involves the central bank purchasing securities from the open market, such as government bonds, eventually that will create money supply in economy (How? When RBI Purchase government bonds from government, And the RBI must pay the money to the Government for the bonds.) and leads to increase in government spending eventually create demand in the economy. This is a strategy is used by Central banks, when the economy is very weak or in the case of there is no significant economic activities not happening in economy.

The main aim of QE is:

•To increase the money supply in the Economy:
By purchasing securities from the governments, the central bank will bring more money into the economy, which can lead to government spending and increased economic activity.

•To reduce interest rates:
By increasing the money supply in the economy, the central bank can lower interest rates, making borrowing more affordable and accessible for the businesses and consumers in the economy.

•To encourage lending and investment:
With more liquidity in the economy, banks can lend more money at a lower rate and invest in other assets, eventually increase economic growth, and increase in employment through providing loans to businesses.

QE is normally Used when economic growth of economy is slow. However, there is a risk that QE can lead to higher inflation over the long term if it is not manageable in a right way.

What is Quantitative tightening?

Quantitative tightening (QT) is the opposite of quantitative easing (QE) and it’s a process of reducing the money supply in the economy and increasing interest rates by selling the assets purchased during Quantitative Easing. In simple language, QT involves the central bank selling the securities it purchased during QE to reduce the amount of money in circulation and increase borrowing costs. QT is used in the times of where inflation is very high.

The main goals of QT are:

•To reduce the money supply in the Economy:

By selling securities, the central bank reduces the amount of money in circulation, which can lead to lower stock prices and decreased economic activity eventually reduce the inflation.

•To increase interest rates:
By reducing the money supply in the economy by central bank increasing interest rates, making borrowing more expensive for businesses and consumers.

•Reducing inflation: As discussed above, by reducing the money supply in the economy, the central bank can prevent inflation from rising too quickly.
QT is typically implemented when the economy of inflation is becoming a concern. QT is an effective tool for controlling inflation and preventing from economic overheating like Continuance of Price increases.
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THE COVID-19 PANDEMIC
The COVID-19 pandemic resulted in a series of unexpected events in the world economies, including a sharp economic downturn. In that time, the Federal Reserve quickly implemented measures to support the economy. One of the key acts was the reduction of interest rates to near zero. This move was targeted at lowering borrowing costs for households and businesses, thereby encouraging spending and investment.
Such that, it will create employment opportunities. In addition to the above, the Fed also purchased Government Securities/assets (QE) to provide further support to financial markets and the economy in the COVID times.
Along with the near Zero Interest rates,
The CARES Act, signed by the Trump in March 2020, provided important fiscal stimulus/assistance to address the issues that arise from economic impact of the pandemic. The relief measures included direct payments to individuals, expanded unemployment benefits, and support for small businesses. These efforts, coupled with the Fed’s monetary policy decisions, supported a relatively quick economic recovery. The Coronavirus Aid, Relief, and Economic Security (CARES) Act, passed in March 2020 by Trump Government was a $2.3 trillion programme in response to the economic downturn caused by the COVID-19 pandemic. It Includes Direct cash payments of $1,200 per adult and $500 per child provided immediate financial assistance to millions, increasing consumer spending, and preventing economic collapse. The large inflow of money from the CARES Act, coupled with government spending (As people has the more money in their hands, they tend to spend) and a challenge in supply chain efficiency, contributed to an increase in aggregate demand exceeding supply, eventually lead to increasing in prices. i.e. Inflation
Let’s Understand the Basic Economics Price will be in constant, where supply and demand equal. If Supply decreases/constant and Demand Increases, there will be increase in Prices. If Supply Increases and Demand Decreases, there will be decrease in Prices.
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Initially, inflation has risen, as predicted with the estimates and Many believed that Inflation to be transitory. Reason? They estimated that the price increases were increased by temporary factors like supply chain shocks, increased demand after lockdowns as there is not much production is done during lockdowns. The estimation was that as supply chains will be normalised and pandemic anxieties will go away, inflation would naturally decrease and settle back within the Fed’s 2% target range, as production will be begin after lifting lockdown eventually supply will offset with demand.
But the Reality is, Inflation remains at the elevated level. At any time sooner, it didn’t come back to normal levels.
Following are the reasons for the same:
CHANGE IN GLOBAL INFLATION DYNAMICS:
SUPPLY SIDE CHANGES:
These means to the factors that comes from the production side of the economy. They include disruptions in supply chains and shortages of raw materials etc.
Ongoing supply chain disruptions and continuous increase production costs, reducing corporate profits etc are the evidence that indicates that these supply chain disturbances might persist longer than initially anticipated.
After lifting the COVID restrictions, there are labour disruptions, port congestion at ports, shipping container scarcities to transport the goods, and the Russia Invasion of Ukraine and OPEC’s production cuts have caused the higher energy prices, eventually results overlapping effect on the cost of goods and services across the sectors. Since, Energy is the fundamental key input in production for many industries. High Energy prices lead to Increase in Production costs of the products. Elevated energy prices attributable to geopolitical tensions are causing the production cost higher.
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The COVID-19 pandemic greatly disrupted global supply chains, causing widespread instability in manufacturing, transportation sectors worldwide. Lockdowns, social distancing measures, border closures, and travel restrictions imposed to control the spread of the virus severely disrupted the movement of goods, services.
Disruptions in global supply chains lead to numerous delays in the delivery of essential inputs and raw materials required for producing goods and services. Eventually, it results in increased production costs and higher prices for final products.
On the other side, shortages of raw materials and intermediate goods can also lead to inflation by producing lesser output that firms can produce at any given time. In particular, the United States faced substantial difficulties importing crucial raw material inputs like computer chips, plastics, and rare earth minerals, primarily imported from Asia and that too from China. Consequently, producers had no choice but to pass along these additional costs to consumers in the form of higher retail selling prices.
DEMAND SIDE CHANGES:
The biggest change in COVID 19 Lockdown has seen in the “Changes in Consumption Patterns of people”.
Demand Side Changes referred to changes in consumption patterns within an economy. This involves shifts in consumer behaviour and spending habits, and financial aid from the government impacted on their consumption pattern.
In Difficult Lockdown measures deployed during the pandemic, consumers restricted to purchase consume only certain durables, household items and services. After lifting the restrictions, the consumer spending patterns have changed drastically. That makes the producers need to supply according to their changed consumer patterns. But, due to supply chain disruptions producers not able to cope up supply with the demand. This leads to persisted inflation of which the FED didn’t expect to present there.
Changes in consumer behaviour might arise due to changed preferences, priorities and habits caused by the pandemic. For Example, people may have shifted toward buying more household items, health products, or working from home equipment such as laptops etc, leading to increased demand for certain goods and services.
Simultaneously, expenditure on discretionary items like dining out, vacations, and leisure activities declined dramatically. Government stimulus measures, such as direct payments to people, unemployment benefits, and lower interest rates, has provided additional money into the economy and boost aggregate demand. As discussed earlier, if there is an excess demand than available supply, it could lead to inflationary pressure on the economy.
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FED’S VIEW ON INFLATION: FED’S INTIAL EXPECTATIONS:
At the beginning of the COVID-19 pandemic, In March 2020, When FED Slashes the Interest rate to near Zero. The Fed anticipated that the upcoming price increases would be temporary, primarily resulting from the supply chain disruptions on economy due to pandemic.
Standing on in this assumption, the Fed maintained a wait-and-see posture, anticipating these temporary price increases fade away over a period. Fed Didn’t think the temporary price increases would have a long-lasting impact on Inflation.
FED believed that these effects would go over a period as economies adapted to new normality, supply constraints were resolved after Lockdown Lifted.
In Short, FED believed “Inflation will be Transitory”.
REASSESMENT OF THE TRANSITORY INFLATION VIEW
Subsequent assessments about inflation revealed that some inflationary pressures persisted longer than initially expected. Eventually, the Fed revised its assessment of the situation. “FED Realised that Inflation is not transitory”. Stating that, prices will be rise more quickly than they originally believed. Another concern for them is, price increases might last longer than they expected and started to increase interest rates from December 2021.
Graph Shows, Interest rates of US from the January 2020 to December 2022.
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IMPACT OF PANDEMIC ON INDIA AND HOW RBI AND THE GOVT. NAVIGATED IT
MONETORY AND FISCAL POLICY MEASURES BY RBI AND INDIAN GOVERNMENT
We often, forget how the RBI is managed efficiently, when compared to other leading central banks in the world during pandemic times.
The COVID-19 pandemic fundamentally shaken the supply chains of the global economies, and India was no exception. The sudden lockdown restrictions and supply chain disruptions led to a decrease in economic activity and a rise in inflation. As there no supply of goods than the demand. To control this unprecedented crisis, the Indian government, and the Reserve Bank of India (RBI) taken a both monetary and fiscal policy measure during the period from March 2020 to till date.
Monetary Policy Measures:
The RBI took rapid action to ease liquidity problems and support credit facility to MSMEs and other Sectors. Key measures are as follows:
•
Cuts in Policy Rates: The repo rate, the rate at which commercial banks borrow from the RBI, was cumulatively reduced by 135 (1.35%) basis points to a record low of 4% by May 2020. This decision is aimed to reduce borrowing costs for businesses and consumers, accelerating investment and spending, for who is having not much purchasing power in the pandemic.
•
Open Market Operations (OMOs): The RBI purchased government securities to provide additional liquidity into the system and boosting market confidence.
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•
Expansion of Monetary Policy Framework: The RBI introduced new instruments like ‘Operation Twist’ to manage the yield curve and support government borrowing.
What is Operational Twist?
Operational twist refers a monetary tool for controlling long-term interest rates in the economy. As Long-term interest is the rate which most companies and Government is borrowed. So, it’s very important that long term interest rates should be low, in contingency times. i.e. COVID times.
The process of Operational twist as follows:
•
The central bank will sell short-term government securities and buys long-term government securities in the open market.
•
This will increase the supply of short-term bonds and decreases the supply of long-term bonds.
•
As a result, the prices of short-term bonds fall, and their yields (interest for sake) rise.
•
At the same time, the prices of long-term bonds rise, and their yields will fall.
This helps, Governments and Institutions can borrow at a lower rate.
Data reveals that, there is an implementation success of these measures in easing liquidity conditions. Bank credit grew of 9.2% by December 2021, compared to 5.3% in April 2021.
However, the impact on inflation was not much on the economy (will discuss why in the below). Despite initial concerns, CPI inflation remained within the RBI’s target range of 4% +/- 2% for most of the pandemic.
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Fiscal Policy Measures:
The Indian government along with the RBI’s actions with a series of fiscal policy interventions aimed at supporting all sections of society and reviving economic activity in the COVID Pandemic.
Some key initiatives included:
•
PM Garib Kalyan Yojana (PMGKY):
This is the best scheme introduced by the government in the COVID-19 pandemic. This scheme provided free food grains and cooking gas to over 800 million beneficiaries for a period of eight months from April 2020.
The scheme’s core component is the free distribution of 5 kg of foodgrains (rice or wheat) per person per month, over and above the regular entitlements and recognizing the financial hardships faced by vulnerable groups, PMGKAY extended one-time cash transfers of ₹500 to various groups, including farmers, migrant workers, women Jan Dhan account holders, and construction workers. Indian Government allocated more resources into providing food security under PMGKY and less resources in the form of Direct Cash Transfers. Which helped to control Inflation.
When compared to USA, in the case. They didn’t have programme like PMGKY. Resulting to providing Pandemic assistance in the form Direct Cash Transfers, which lead to High Consumer spending on Food products with the given cash. Eventually, Leads to High Inflation.
These monetary infusions provided immediate relief and helped families meet essential needs. PMGKY played a crucial role in mitigating food insecurity and protecting the livelihood of low-income households in the country. PMGKY successfully prevented large-scale food insecurity and economic distress. Data shows that poverty rates remained broadly stable during the pandemic.
•
Emergency Credit Line Guarantee Scheme (ECLGS):
The Indian Government, guaranteed loans to businesses in specific sectors affected by the pandemic, reducing credit risk and promoting lending by banks. As of March 2023, ECLGS supported loans exceeding Rs 5.5 lakh crore, helping businesses stay afloat in the turbulent times and retain employees. ECLGS
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achieved its objective, with over 5 million units availing loans under the scheme.
Conclusion:
Analysing real-time data paints, a clear picture of India’s success. While inflation initially spiked in both countries, India’s CPI inflation remained within the RBI’s target range for most of the pandemic, thanks to measures like PMGKY. India’s CPI inflation remained within the RBI’s target range of 4% +/- 2% for most of the period. This remarkable feat can be partially attributed to the reduced demand for food items due to PMGKY. With limited Fiscal/Financial Resources and a massive population vulnerable to food insecurity, India’s pandemic response Prioritised direct support to the most affected sections, mostly poor. The PMGKY scheme helped to achieving the above target.
This direct food security benefit transfer not only ensured food security for millions but also had a crucial secondary effect – it freed up household budgets previously dedicated to food purchases. I.e. Indian Household spend the less amount on food in the pandemic as they secured by PMGKY.
This, in turn, controlled aggregate demand, helping to control food inflationary pressures. Conversely, the US faced persistently high inflation, fuelled by factors like supply chain disruptions and the huge cash handouts through CARES Act. Additionally, ECLGS supported over 5 million units in India, compared to the CARES Act’s broader and less targeted approach.
Additionally, poverty rates remained broadly stable during the pandemic, State that the scheme’s effectiveness in protecting vulnerable populations in the country. Along with the PMGKY, ECLGS also supported the economy, by guarantees on loans to businesses in specific sectors affected by the pandemic, mitigating credit risk and promoting lending by banks.
In contrast,
The US adopted a more stimulus-heavy approach through the CARES Act. Which is by simply distributing cash, resulted in increased inflation rather than targeted economic support. While this provided immediate relief to citizens and businesses, it
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also infused a significant amount of cash into the economy. Along with that, the US Federal Reserve’s quantitative easing (QE) program, while providing ample liquidity, also contributed to asset inflation. This, coupled with supply chain challenges, led to a surge in demand for goods and services, over and above than the available supply. Consequently, the US witnessed a sharp rise in inflation, reaching a 40-year high in 2022.
The United States, despite boasting a larger and more developed economy, failed in its pandemic response. The CARES Act, while well-intentioned, proved to be a failure instrument, leading to inflated asset prices, and exacerbating pre-existing income inequalities.
Even today, US is facing the pinch of Government and FED decision taken in the Pandemic time. As FED is not able to manage the Inflation, that caused by the Pandemic actions.
The reliance on QE further fuelled inflation, creating a challenging economic scenario. Additionally, the lack of a targeted program like PMGKY left vulnerable sections of society facing food insecurity and financial hardship. Eventually, Lead to households increase spending in Food items leading to increase in Food inflation.
The differing approaches of the RBI and the Fed further resulted in the contrasting outcomes. The RBI’s focus on targeted liquidity injections and a gradual withdrawal of QE measures (implementing QT) helped manage inflation and maintain financial stability.
In contrast, the Fed’s prolonged QE program, and (assumed mistake of inflation is transitory) while providing much-needed liquidity, contributed to inflationary pressures and asset bubbles.
While both India and the US faced unprecedented challenges during the pandemic, their contrasting approaches resulted different outcomes. India’s targeted interventions by PMGKY and ECLGS, combined with the RBI’s sound monetary policy, helped it navigate the crisis is a example of how economies can respond/deal with of unprecedent Challenges.
The US, on the other hand, struggled with inflation and rising inequality due to large stimulus measures and QE programs. From this, we can say money itself cannot be able to solve the problems. As the world recovers from the pandemic, the lessons learned
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from these contrasting experiences can serve as valuable guiding principles for navigating future economic challenges, emphasizing the importance Central Banks and Governments with of targeted interventions, data-driven decision-making, and a optimal balance between fiscal and monetary policy.
References:
1)
https://www.weforum.org/agenda/2022/11/global-economy-us-interest-rate-break-december/
2)
https://www.ibef.org/government-schemes/pradhan-mantri-garib-kalyan-yojana
3)
https://www.seia.org/research-resources/cares-act-highlights-key-provisions
4)
https://www.washingtonpost.com/business/2020/03/15/federal-reserve-slashes-interest-rates-zero-part-wide-ranging-emergency-intervention/
5)
https://blog.tatanexarc.com/msme/eclg-emergency-credit-line-guarantee-scheme/