Persisting global events and supply shocks always result in economic repercussions. Whether it was the Covid-19 pandemic or the Russia-Ukraine war, economic fluctuations cause uncertainty for buyers and sellers alike, making it harder for investors and businesses to speculate as well. Changes in investments from both domestic and foreign firms impact various global economies. It is therefore essential that governments and their respective central banks administer policy changes to correct and minimise fluctuations in economic activity.
When economies slip into a recessionary gap, the government and central bank must implement expansionary demand-side policies to help the economy stabilise by promoting transactions, increasing government expenditure, lowering personal income and corporate taxes, increasing the money supply in an economy, and decreasing interest rates. Similarly, contractionary demand-side policies need to be administered during periods of an inflationary gap – policies where government expenditure and money supplies are lowered and taxation and interest rates are increased. The pandemic bolstered the global economy into a precarious recessionary gap, where prospects of economic recovery looked bleak amidst the global standstill.
During the pandemic, the US government implemented expansionary monetary policies by reducing interest rates to close to 0%. Alongside this, the government also passed several bills to invest money into the economy, such as Biden’s $1 trillion infrastructure bill and the increase of unemployment benefits to $600/week. Other countries and governments also employed expansionary demand-side policies, which significantly aided economic recovery. However, economic activities increased with such fortitude that the global economy has now entered an inflationary phase, a prominent consequence of expansionary demand-side policies.
However, it was not government ineffectiveness that led to inflation. It occurred due to the multiplier effect: government expenditure resulted in higher consumer and investment expenditure, thus strengthening the economy by a greater monetary value than the initial government investment.
Presently, both governments and central banks are implementing contractionary fiscal and monetary policies to manage inflation: they have lowered unemployment benefits and increased interest rates. The central bank first increased interest rates by 40 basis points in India itself and now by another 50 basis points.
The role of demand-side policies in economic recovery in the short run is inevitable and crucial. However, these are short term policies, as governments cannot keep altering interest rates and money supply due to the uncertainty it would elicit in the economy. Governments must implement interventionist and market-based supply-side policies for long-term economic growth, development, and stability.
