Assessment of the Nature of the Pandemic Shock: Implications for Monetary Policy

The coronavirus pandemic and the related anti-epidemic measures represented an unprecedented negative shock to the global economy in the form of a dramatic fall in economic activity. Since the onset of the pandemic, the question has been to what extent the contraction of economic activity, largely related to anti-epidemic measures (lockdowns), can be interpreted as a negative anti-inflationary shock to demand and, conversely, what proportion of the observed decline in GDP can be attributed to a negative (cost) inflationary shock on the supply side. To contribute to the debate, we have set out our own narrative and conducted model analyses. We have focused on the world's two largest advanced economies - the US and the euro area. An empirical comparison of the pandemic-induced crisis with the global financial and economic crisis and model simulations indicate that the sharp economic downturn observed in 2020 bears, for the most part, the hallmarks of a supply shock. The combination of a negative supply shock, worldwide accommodative monetary policy and large fiscal stimuli led to strong inflationary overheating across the globe. The Czech National Bank reassessed the macroeconomic story from a demand to supply driven economic downturn. This reassessment, together with a gradual, but steady, recovery of economic activity, enabled the CNB - as one of the first central banks in the world to do so - to appropriately tighten its monetary policy from mid-2021 onwards.