The Economic Implications of Coronavirus: Financial markets are falling

Aurora Ceccotti

By Aurora Ceccotti

Credits: InvestireOggi

The global aggregate bond and stock paper wealth have crashed 25 trillion dollars since the 21st of February and all global gains from stocks and bonds since December 2018 have been erased.

The US is experiencing what Keynes named a liquidity trap, i.e. a condition under which monetary policies result to be inefficient. In a normal condition, for instance, central banks stimulate investment through a reduction of interest rates. Currently, the financial market does not seem to be responsive to such stimulus, as the implementation of quantitative easing and the reduction of rates of interest did not prevent stocks and corporate bonds prices to decrease and yields to increase. In practice, this condition leads to higher borrowing costs and lower spending. 

A further indicator of a liquidity trap condition is the TED spread. It represents the difference between interbank interest rates and 3-month treasury bill interest rate (i.e. the short run government bonds issued by the US government). TED spread and interbank interest rates are directly related; on the other hand, if bonds increase, TED spread decreases.

It is to note that US government bonds are one of the safest assets as the US government cannot default. A sudden increase in the TED level represents a sudden increase in interbank interest rates, suggesting a significant level of perceived credit risk in the economy. A spread above 0.48% indicates a crisis. On the 9th of March, it reached 0.45%.

A sudden increase of TED means that interbank increase, therefore liquidity trap is experienced.

What clearly suggests such a phenomenon is that a high level of spread occurs despite the implementation of expansionary monetary policies by the FED, such as but not limited to an increase in money supply and concession of loans at a low interest rate.

Clearly, monetary policies do not seem to be effective.

  • What policies could be applied in order to mitigate the impact of the pandemic on the economy?

Suggested further reading:

https://www.opendemocracy.net/en/oureconomy/helicopter-money-answer-looming-economic-crisis/

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