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Jakarta Post

Monetary policy beyond low inflation

  • Dedy Swares Sinaga

    New Haven, the United States

New Haven, the United States   /   Tue, June 30 2020   /  08:30 am
The gatekeeper: The logo of Bank Indonesia marks the central bank’s gate on Jl. Thamrin in Central Jakarta. The bank has cut its seven-day reverse repo rate several times to help the country recover from the crisis inflicted by the COVID-19 pandemic.(The Jakarta Post/Rafaela Chandra)

In response to the COVID-19 pandemic, central banks around the world have been experimenting with unconventional policies. Normally, standard macroeconomic models prescribe substantial policy rate cuts during economic downturns to provide cushions to the economy. But central banks cannot always adhere to this prescription. The United States Federal Reserves (Fed), for example, cut its policy rate by the average of 5.5 percent during recessions since 1957. But the Fed Funds Rate (FFR) was already at 1.75 percent in February 2020. So it had to be set at minus 3.75 percent to follow the historical patterns. As setting negative rates is equal to taxing deposits, it can prompt fund owners to withdraw money from the banking system and to hoard cash instead. Hence, contrary to the normal nexus where a lower interest stimulates the economy, rate cuts below zero can discourage economic acti...