Does the Covid-19 Shock Matter for Monetary Policy?

Abstract

This paper explores for the first time how the Covid-19 shock affects a monetary policy rule after it has been separated from other potential structural shocks. The novelty of this empirical analysis will illustrate explicitly why monetary authorities can respond immediately to the pandemic crisis by cutting policy rates. The findings show that central banks behave differently to different types of shock, with the long-run responses of policy rates to inflation meeting the Taylor principle for the Covid-19 shock. The results are robust to alternative modelling specifications. Monetary policy rules that explicitly consider the pandemic crisis can play a vital role in limiting the economic and financial damage caused by efforts to contain Covid-19 and, in that way, can help support the strict public health measures that are needed to save lives and set the stage for economic recovery.