During the initial shock from COVID-19, it was understandable that governments and central banks would respond with massive injections of liquidity. But now policymakers need to take a step back and consider which forms of stimulus are really needed, and which risk doing more harm than good.

NEW YORK – Governments around the world are responding forcefully to the COVID-19 crisis with a combined fiscal and monetary response that has already reached 10% of global GDP. Yet according to the latest global assessment from the United Nations Department of Economic and Social Affairs, these stimulus measures may not boost consumption and investment by as much as policymakers are hoping.

The problem is that a significant portion of the money is being funneled directly into capital buffers, leading to an increase in precautionary balances. The situation is akin to the “liquidity trap” that so worried John Maynard Keynes during the Great Depression.

Today’s stimulus measures have understandably been rolled out in haste – almost in panic – to contain the economic fallout from the pandemic. And while this fire-hose approach was neither targeted nor precise, many commentators would argue that it was the only option at the time. Without a massive injection of emergency liquidity, there probably would have been widespread bankruptcies, losses of organizational capital, and an even steeper path to recovery.

But it is now clear that the pandemic will last much longer than a few weeks, as was initially assumed when these emergency measures were enacted. That means these programs all need to be assessed more carefully, with an eye to the long term. During periods of deep uncertainty, precautionary savings typically rise as households and businesses hold on to cash for fear of what lies ahead.

The current crisis is no exception. Much of the money that households and businesses receive in the form of stimulus checks will probably sit idle in their bank accounts, owing to anxieties about the future and a broader reduction in spending opportunities. At the same time, banks will likely have to sit on the excess liquidity, for lack of credit-worthy borrowers willing to take out fresh loans.

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