In Major Economic Shocks

During times of great economic upheaval, the most effective response involves the implementation of all-encompassing and wide-ranging policies. Specifically, countries that utilized a combination of substantial fiscal, monetary, and prudential measures experienced accelerated bank lending. According to our analysis, this response is necessary to facilitate corporate borrowing and credit growth during future global crises that result from disruptions in both supply and demand.

In order to arrive at this conclusion, we studied a dataset we had previously created that tracks national declarations of economic and financial policy responses to the pandemic. Over the course of 2020, it was discovered that nations most often implemented packages containing more than one fiscal, monetary, or prudential policy, while standalone policy declarations were few and far between.

As the pandemic initially caused credit growth to decline rapidly, policymakers in numerous nations endeavored to stabilize bank lending in order to maintain the stability of their economies. Our research indicates that all-encompassing policy packages boosted credit growth by a considerable 5 percentage points per quarter. Both the size and scope of the policies were of critical importance: even packages that combined all types of policies, but where only some were substantial, were less effective.

Our findings highlight the importance of comprehensive policy packages, as all granular policy tools we monitored were more frequently utilized in successful packages than in others.

These all-encompassing responses may have been effective because, in the face of a substantial and unforeseen global shock, they utilized every relevant lever in order to facilitate credit growth. They removed regulatory requirements that served as binding constraints, provided incentives for incremental lending, and addressed heightened concerns about credit risk. They also supported credit demand by lowering borrowing costs.

In banks, the policies had a greater impact on those that were constrained by thin capital buffers.

Packages that combined large fiscal, monetary, and prudential measures also provided additional access to liquidity for bank-dependent firms, allowing them to cover expenses like wage bills for two additional months while health measures restricted sales.

While economic and financial policy packages related to COVID-19 were broad in their scope, they did not appear to disproportionately benefit firms with poor pre-pandemic performance.

Our research underscores the importance of decisive and broad action in terms of pandemic policy responses. During future crises that result from negative supply and demand shocks and significant uncertainty, a similarly concerted, coordinated, and all-encompassing approach may have an important role in supporting the economy.

It should be noted, however, that not all countries are capable of responding to global shocks in such an aggressive manner. In particular, emerging and developing economies will likely continue to be more constrained, as they were during this episode.

It is worth considering that an all-encompassing approach could also have unintended consequences. Large fiscal and monetary packages could support credit and the economy, but also create inflationary pressures. In countries with high debt, an increase in discretionary spending could strain debt sustainability. Further research is needed to better understand how to calibrate an appropriate all-encompassing response that minimizes such costs.