Policy in Times of COVID-19

Unconventional Monetary

Unconventional Monetary
Policy in Times of COVID-19
(UMPTs)
 Introduction
Unconventional monetary policy tools (UMPTs) significantly differ from
conventional instruments in terms of the
Unconventional Monetary Policy in Times of

i) Nature of policy actions,

ii) Their rationale,
iii) The channels through which they work &
COVID-19

iv) The scale of operations.

The Reserve Bank (RBI) undertook several unconventional measures in the
wake of COVID-19 that have laid the foundations for economic revival, going
ahead, mainly, long-term repo operations (LTROs), support credit offtake while
targeted long-term repo operations (TLTROs), Special OMOs (Operation
Twists) and other UMPTs.
 Background
*Why conventional policy tools become impotent?
With the advent of inflation targeting Since 1990s , central banks in
Unconventional Monetary Policy in Times of

advanced economies (AEs) have typically used a short-term interest rate as

their principal monetary policy instrument.
In response to the global financial crisis (GFC), many AE central banks
lowered their policy interest rates to near-zero levels.
COVID-19

The persistence of such low rates, rendered conventional policy tools

impotent, and impaired the monetary transmission mechanism.
Some central banks introduced UMPTs.
UMPTs provided greater leeway to central banks during the GFC, were
redeployed after the outbreak of COVID-19 to mitigate its deleterious
impact on financial conditions and economic activity.
.
Unconventional Monetary Policy in Times of

A synoptic view of various Unconventional

Monetary Policy Tools( UMPTs)
&
COVID-19

their rationale
 Unconventional Monetary Policy Tools (UMPTs)
Tools of UMPTs
Unconventional Monetary Policy in Times of

(i) Negative Interest Rate Policies (NIRPs):

(ii) Extended Lending or Term-Funding Operations (ELO/TFO):
(iii) Asset Purchase Programmes (APPs):
(iv) Forward Guidance (FG):
COVID-19
 i) Negative Interest Rate Policies (NIRPs)
A negative interest rate policy (NIRP) occurs when a central
bank sets its target nominal interest rate at less than zero
Unconventional Monetary Policy in Times of

percent.
NIR are truly unconventional as it is difficult to justify that
depositors would be taxed for placing funds with banks.
COVID-19

Since 2012, a number of central banks introduced negative

interest rate policies.
Central banks in Denmark, euro area, Japan, Sweden, and
Switzerland turned to such policies in response to persistently
below-target inflation rates .
most central banks set rates as part of their broader mandate to
keep prices stable, thereby supporting jobs and economic growth.
 i) Negative Interest Rate Policies (NIRPs)
• A negative interest rate policy (NIRP) occurs when a central bank sets its target nominal
interest rate at less than zero percent.
Unconventional Monetary Policy in Times of

• This extraordinary monetary policy tool is used to strongly encourage borrowing,

spending, and investment rather than hoarding cash, which will lose value to negative
deposit rates.
• Officially set negative rates have been seen in practice following the 2008 financial
crisis in several jurisdictions such as in parts of Europe and in Japan.
COVID-19

• Instead of receiving money on deposits, depositors must pay regularly to keep their
money with the bank. This is intended to incentivize banks to lend money more freely
and businesses and individuals to invest, lend, and spend money rather than pay a fee to
keep it safe. This happens during a negative interest rate environment.
• An example of a negative interest rate policy would be to set the key rate at -0.2 percent,
such that bank depositors would have to pay two-tenths of a percent on their deposits
instead of receiving any sort of positive interest.
• In 2014, the European Central Bank (ECB) instituted a negative interest rate that only
applied to bank deposits intended to prevent the Eurozone from falling into a
deflationary spiral.
 i) Negative Interest Rate Policies (NIRPs) cont…
The economic shock from the COVID-19 pandemic prompted
policymakers to consider adopting negative interest rates on bank
Unconventional Monetary Policy in Times of

reserves to support the recovery.

In emerging market economies (EMEs), NIRPs can cause
(i)large cross-border spillovers in the form of a deluge of capital
COVID-19

inflows in search of yields,

(ii)Posing enormous monetary policy &
(iii) Financial stability challenges.
 (ii) Extended Lending or Term-Funding Operations (ELO/TFO):

• Following the GFC and after the pandemic, many central banks
Unconventional Monetary Policy in Times of

provided low-cost long-term funding to financial institutions at

concessional rates.
• It enables them to pass on the benefits to businesses and households.
• Although such facilities supported credit flows to the private sector,
COVID-19

they also occasionally resulted in inefficient credit allocation by

(i) compromising loan quality &
(ii) acted as a disincentive to reducing excessive leverage.
Nevertheless, these measures eased liquidity strains in highly
stressed bank funding markets and helped restore monetary transmission
channels (Lowe, 2019).
 (iii) Asset Purchase Programmes (APPs):
APPs:
 involve the outright purchase of assets (mainly government bonds) by
Unconventional Monetary Policy in Times of

central banks & have long been a feature of their liquidity management
operations;
 used more extensively after the GFC and in response to COVID-19,
COVID-19

Lea to large expansion of central bank balance sheets.

Typically, a central bank can either set
(i) quantity target- known as quantitative easing (QE): a target for the
quantity of assets it will purchase (at any price); or
(ii) price target -known as yield curve control (YCC): a target for the
asset price (purchasing any quantity that would achieve the targeted
price).
 (iv) Forward Guidance (FG):

• Forward guidance (FG) : pertains to central bank communication on the future path of the
policy interest rate.
Unconventional Monetary Policy in Times of

• it is both implicit and explicit

• FG can be (a) time-based; or (b) state-based.
(a) time-based guidance:
• Under it the central bank commits to a stance of monetary policy until a specific point in
COVID-19

time.
• They remained committed to price stability.
• During the GFC and COVID-19, central banks were active in providing FG to (i) reinforce
their commitment to low interest rates; and (ii) communicate their strategy in uncertain times.
(b) state-based guidance: pertains to a stance until an explicit set of economic conditions are
met. In a period of heighted uncertainty about the economic outlook, FG played an
indispensable role in clarifying central banks’ intent while they remained committed to price
stability.
 Background of
In addition to the above-mentioned UMPTs, many central banks made
significant adjustments in their market operations such as
Unconventional Monetary Policy in Times of

(i)injecting unprecedentedly large liquidity;

(ii)expanding the range of collaterals; &
(iii)widening the range of ‘eligible counterparties’.
COVID-19

These refinements sought to address market seizure and illiquidity

 UMPTs during Covid-19: Cross-country Practices
Unconventional Monetary Policy in Times of
COVID-19
 IUMPTs during Covid-19: Cross-country Practices

Based on their GFC experience, to restore normalcy in financial markets and

minimise the loss of economic activity, central banks designed and
Unconventional Monetary Policy in Times of

implemented various UMP measures during post COVID-19, such as;

(i) Negative Interest Rate Policy:
• Many AE central banks continued with negative interest rates adopted during
GFC.
COVID-19

• The Swiss National Bank (SNB) maintained its policy rate at -0.75%
• European Central Bank (ECB)’s standing deposit facility rate is currently at -
0.50 per cent & maintained interest rate to 0.1%
• The US Fed dropped its benchmark interest rate to 0-0.25% in March 2020.
• The Swedish Riksbank also reduced its lending rate for overnight loans
in phases to 0.1 %.
 IUMPTs during Covid-19: Cross-country Practices
cont…
(ii) Liquidity support through new instruments:
• Most central banks have lowered reserve requirements,
Unconventional Monetary Policy in Times of

• eased collateral norms &

• increased the scale and tenor of repo operations.
(iii) Asset Purchases:
COVID-19

• Central banks also expanded their APPs to meet additional demand for bank
reserves arising from pandemic-induced
elevated uncertainty and facilitate lower long-term interest rates.
• The BoE expanded its holding of UK government bonds and non financial
investment grade corporate bonds by £300 billion.
• In March, the ECB introduced the pandemic emergency purchase program
(PEPP) which was increased in purchases to 1.85 trillion and its duration was
extended to end-March 2022.
 IUMPTs during Covid-19: Cross-country Practices
cont…
(iv) Forward Guidance:
• The Fed indicated that rates will remain low until the economy has weathered recent events and
Unconventional Monetary Policy in Times of

was on track to achieve its maximum employment and price stability goals.
• The ECB expected rates to remain at their present or lower levels
until the inflation outlook converges close to, but below, 2 %.
• In addition, many central banks have resorted to regulatory and supervisory measures including
COVID-19

(a) reduction in countercyclical capital buffers;

(b) relaxation in liquidity coverage ratio (LCR);
(c) suspension of dividend and buyback;
(d) relaxation in debt restructuring and loss provisioning;
(e) slackening of prudential norms and
(f) regulatory forbearance in reporting and compliance.
 UMPTs – The Indian Experience
Unconventional Monetary Policy in Times of
COVID-19
 UMPTs – The Indian Experience
The Reserve Bank undertook several conventional and unconventional
measures in the wake of COVID-19.
Unconventional Monetary Policy in Times of

Conventional measures included

(i) reduction in the policy repo rate by 115 bps and
(ii) cash reserve ratio (CRR) by 100 bps,
COVID-19

Unconventional measures featured

(iii) extended lending or term funding operations including liquidity
support
through refinance;
(iv) asset purchase programmes including operation twists (OTs); and
(v) Forward guidance,
 Broad UMPTs measures in India
(i)Liquidity Support Operations comprises of
(a) Extended lending/term-funding &
Unconventional Monetary Policy in Times of

(b) Liquidity support

(a) Extended lending/term-funding:
• Akin to the ECB after the GFC, the RBI introduced long term repo operations
(LTROs) in February 2020 to facilitate monetary policy transmission and
COVID-19

support credit offtake.

• Under the scheme, the RBI provided long-term liquidity to banks at the
erstwhile policy repo rate (5.15 per cent) to lower their cost of funds.
• During February-March 2020, fie LTRO auctions were conducted, which
augmented system liquidity by `1,25,117 crore.
• In September 2020, however, banks repaid 1,23,572 crore to reduce their
cost of funds by exercising an option of prepayment before maturity.
 (a) Extended lending/term-funding cont…
• The outbreak of COVID-19 ignited selloff pressures in financial markets
Unconventional Monetary Policy in Times of

• Financial conditions tightened as sharp spikes in risk premium on corporate

bonds, CPs and debentures dried up trading activity resulting in market
illiquidity.
• Accordingly, targeted long-term repo operations (TLTROs) were
COVID-19

introduced to provide liquidity to specific sectors and entities experiencing

liquidity stress.
• TLTRO auctions were conducted during March April 2020 providing
1,00,050 crore to banks for deployment in investment grade corporate
bonds, CPs, and non-convertible debentures.
• Since the deployment of TLTRO funds was largely confined to public
sector entities and large corporates, TLTRO 2.0 was introduced to provide
relief to the small and mid-sized corporates, including NBFCs and MFIs.
 (b) Liquidity support
Liquidity support:
• In view of tightening financial conditions, all India financial institutions
Unconventional Monetary Policy in Times of

(AIFIs) were facing difficulties in raising resources.

• Total refinance support to AIFIs amounted to `75,000 crore.
• To alleviate their liquidity stress and meet sectoral credit needs, special
refinance facilities for a total amount of `60,000 crore were provided at the
COVID-19

policy repo rate such as

 NABARD -30,000
 SIDBI-15000 crore &
 NHB- 15000 crore.

• A line of credit of `15,000 crore was extended to the EXIM Bank for a period
of 90 days to avail a US dollar swap facility to meet its foreign exchange
requirements.
 (ii) Asset Purchase Programme (APP):

• Unlike many central banks, the Reserve Bank’s purchases have been
confined to the secondary market and solely in government securities.
Unconventional Monetary Policy in Times of

• An innovation has been the inclusion of state government securities in

October 2020 – commonly known as state development loans (SDLs) – as
a special case for 2020-21.
COVID-19

• Net OMO purchases amounted to `3,04,754 crore (including SDLs worth

`30,000 crore) during 2020-21.
 (iii) Forward Guidance (FG)
• In the aftermath of the pandemic, FG gained prominence in the Reserve
Bank’s communication strategy to support the accommodative stance of the
Unconventional Monetary Policy in Times of

monetary policy committee (MPC).

• The MPC’s reiteration that the policy stance would remain accommodative
till the revival of growth epitomizes explicit time contingent and state-
contingent FG.
COVID-19

• Moreover, the Governor assured financial markets that the RBI will
maintain comfortable liquidity conditions in sync with the monetary policy
stance.
• Thus, FG complimented other UMPT measures in the post-COVID
environment.
 Currency Demand Paradox

BITS Pilani
Pilani Campus
Introduction

• The currency demand paradox, often referred to as the “paradox of

banknotes,” is a phenomenon where the value of banknotes in circulation
increases despite a decline in their use for payments.
• In recent years, a growing trend in the share of cash in gross domestic product
(GDP) has been observed. This trend has occurred even though an increasing
number of transactions are now being carried out with the use of electronic
payment instruments.
• The phenomenon of the simultaneous increase of the cash/GDP ratio and the
increase in the number of non-cash transactions is often referred to as the
“cash paradox”

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

 Introduction

• Retail digital payments in India have experienced impressive growth in both volume and
value. From 2016-17 to 2021-22, digital payments led by the Unified Payments Interface
(UPI) exhibited a compound annual growth rate (CAGR) of 50% in volume and 27% in
value.
• This substantial expansion highlights the increasing adoption of digital payment modes in
the country.
• Further, COVID-19 has intensified this paradox as the rising uncertainties increased
• cash demand, despite accelerated migration to digital modes of payments.
• In India, while the Unified Payments Interface (UPI)-led retail digital payments grew at a
compounded annual growth rate (CAGR) of 50 per cent and 27 per cent in terms of
volume and value, respectively (during 2016-17 to 2021-22), the currency in circulation
(CiC) to GDP ratio also rose and peaked at 14.4 per cent in 2020- 21.

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

 Introduction: Currency Demand
• Currency represents a unique combination of liquidity,
security and privacy.
• The demand for currency primarily relates to
transactions demand, i.e., the need to carry out cash
transactions in both the official and unofficial sectors.
• Besides the transactions demand, a part of currency,
being the most liquid form of money, is also held by the
public and the firms as a precautionary measure.
Currency can very often be “hoarded” especially in the
unofficial sector.
• The key determinants of the demand for currency are the
transactions motive and the desire to have a liquid
medium for storing value.

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

 Currency Demand: Transactions Demand

• Domestic demand for currency in the US is largely based on the use of currency for
transactions and is influenced primarily by income levels, prices of goods and services,
the availability of alternative payment methods, and the opportunity cost of holding
currency in lieu of an interest-bearing asset.
• Consumers frequently use smaller-denomination notes for small transactions and
alternative payment methods (for example, debit and credit cards) for larger purchases.
• In contrast, foreign demand for US currency is influenced primarily by the political and
economic uncertainties associated with certain foreign currencies, which contrast with
the U.S. dollar's historically relatively high degree of stability.

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 Currency Demand: Demand for Hoarding

• When currency is used as a store of value, there can be a strong elasticity of the demand
for cash with respect to interest rates (and, in open economies, exchange rates). Holders
may even economize on transaction cash balances when interest rates rise.
• The most commonly used method for modelling hoarding demand for currency is the age
of bank notes or the lifetime method.
• Under this method, the average life of various denominations of bank notes serves as an
indicator of currency usage for transactions/hoarding, with a relatively high note life of a
particular denomination indicating lower intensity of use (for transactions purposes), and a
greater use for hoarding.
• The life-time method has been a popular method for estimating the volume of hoarded
banknotes.

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 Currency Demand: Demand for Hoarding

• Studies of this genre assume that smaller denomination currencies are used only for
transactions and assuming that the average life of small denomination notes is the normal
average life of the banknotes, the percentage of notes of a higher denomination used for
hoarding is calculated

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Currency Demand: cross Country Evidences

• There exists are significant cross country

heterogeneity in the currency-GDP ratio.

• Japan has high currency-GDP ration relative

to others

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Currency Demand Paradox : India

• In many emerging market economies, especially in India, there has been a secular
increase in currency demand in relation to GDP, partly reflecting increasing monetisation
and commercialisation of the economy while the introduction of electronic modes of
transactions has been relatively recent and is yet to be reflected in a lowered currency
demand.
• In India, the decadal average currency-GDP ratio hovered around 10 per cent in the
1970s, 1980s and 1990s, but increased to over 13 per cent in the last decade.
• Notably, currency to private consumption ratio also has gone up substantially from 12.6
per cent in the 80s to 14.8 per cent in the 90s to 19.1 per cent in the last decade, despite
rapid spread of non-cash payment modes.

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

 Factors Affecting: Currency Demand

• Currency demand depends on country specific circumstances. These factors are,

technological, cultural and socioecological factors that influence currency demand differ
across countries.
• The cross-country variations in growth, inflation and interest rates, the rate of direct and
indirect taxes.
• Apart from this the share of informal and underground economy in the overall economic
activity and the organization of economic activity (viz., dominance of retail vis-à-vis
large-scale business), regulation of various modes of payment, proportion of migrant
workers, the nature of currency (‘soft’ or ‘hard’), etc. are among the important
explanatory economic factors.

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Currency Demand Paradox in India

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Cross-Country

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

 Currency Demand Paradox in India

• In its Annual Report, the RBI attributes the currency

paradox to four reasons:
1. The persistent affinity for cash has been attributed
to factors such as the decline in opportunity costs of
holding currency, i.e., interest rates
2. Precautionary holdings amid uncertainty
3. Presence of a large informal economy
4. Direct benefit transfers by the government,
promoting both cash and digital modes, as routing
of benefits digitally tends to be followed by cash
withdrawals.

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 Other factors affecting

• Two other explanations for the increase in the share of cash in GDP indicated in the
literature are crises in the real sector and financial crises.
• The main argument regarding the consequences of the crisis in the real sector (GDP
decline) is that there is an incomplete immediate adjustment by economic agents to
changes in the real sector.
• A Monetary History of the United States indicate that if we assume that economic agents
react to permanent income rather than current income, then they will maintain surplus
cash reserves in periods of GDP decline.
• Therefore, the level of maintained cash relative to the current GDP will grow, as
economic agents will not adjust their demand for money to the decline in GDP.
Unfortunately, there are no studies that systematically verify this issue.

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

 Other Factors Affecting

• Financial crises, periods of financial system instability, and banking panic can increase
the interest in cash as it is seen as a relatively safe reserve asset. Both the Great
Depression of the 1930s and the 2007+ crisis resulted in an increase in the share of
cash in circulation in major economies.
• Literature examined the effects of the banking crises related to the 2007–8 financial
crisis, found an increase in the share of cash in major developed economies. However,
they caution that only a small number of economies were hit by the 2008 banking
crisis.

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 Currency Demand Paradox and Covid-19

• The Covid-19 pandemic intensified the currency paradox. A sudden uptick in the
growth of currency in circulation during the pandemic can be attributed to the
precautionary and store-of-value motives as households grew wary of economic
prospects, the RBI says.
• However, the transactional use of cash has progressively been substituted by digital
modes.
• Now, there is a turnaround in the pandemic-induced precautionary motives.
• For the week ending March 24, 2023, currency in circulation grew by 7.8 per cent year-
on-year, recording single-digit growth for 86 weeks since August 2021 (barring April
2022) and averaging overall at 8.5 per cent, the RBI says.
• Concurrently, digital payment modes continue to maintain strong growth momentum
after the pandemic.
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Thanks

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956