Fiscal and monetary policy during the pandemic in Canada: a quantitative analysis

We build a two-agent New Keynesian (TANK) model, augmented with the central bank balance sheet and government budget constraint, to quantify macroeconomic effects of the fiscal and monetary stimulus measures in Canada during the COVID-19 pandemic. The model is calibrated to the Canadian economy, and shock processes are estimated. The model closely replicates the observed dynamics of the economy over the pandemic period. Counterfactual experiments reveal that transfer payments played a key role in cushioning the initial contraction by supporting the consumption of hand-to-mouth (HtM) households, while forward guidance and quantitative easing strengthen these effects through the investment channel and by forestalling a severe deflationary episode. At the same time, the prolonged maintenance of low policy interest rate, in conjunction with large-scale fiscal transfers, contributed substantially to the post-pandemic surge in inflation. We show that an earlier normalization of monetary policy would have significantly reduced post-pandemic inflation at only modest cost to output, suggesting that a more gradual tightening path could have reduced the need for the aggressive interest rate increases that followed.