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Home / Opinion / Quick Edit /  Opinion | The Fed’s free money may not work

An interest rate of zero? It’s free money, but that is roughly what the US Federal Reserve has on offer. As part of its emergency stimulus measures in the face of the coronavirus crisis, America’s central bank has reduced its policy rate to a band of 0-0.25%. It also promised $700 billion worth of treasury and bond purchases to ensure financial markets don’t freeze up.

These drastic measures are reminiscent of the Great Recession of 2008-09, when the Fed had last eased money with such gusto. This time, however, it is a crisis of another kind. While easing credit could pump cash around for banks, market operators and businesses to tide over a sharp liquidity crunch, it is unlikely to act as a stimulus in the usual sense. After all, it is the fear of coronavirus contagion that is causing seizures all around, and the price of money is not much of a factor.

All the same, India’s central bank will probably have to cut its own repurchase rate, the one at which it effectively lends money to regular banks. Lowering rates in line with the rest of the world helps keep cross-border currency flows on an even keel. Other than that, India faces a business crunch too. Growth was already sluggish (under an annual 5%) before the Covid-19 disruption hit, and while inflation has gone up lately (and was above its 6% upper limit in February), the Reserve Bank of India could opt to err on the side of a negative real rate—for a while—just to safeguard the economy. Whether super-low real rates can be sustained is another matter. In theory, free money tends to push a credit system towards a liquidity trap, where both the demand and supply of money slump and no market player has an incentive to lend to anyone.

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