The Covid-19 pandemic calls for a drastic change in Kenya’s economic policy this year and in future. President Uhuru Kenyatta has already announced several fiscal and monetary interventions to respond to the Covid-19 pandemic.
The question that is lingering in people’s minds now is whether these measures will safeguard the economy during the Covid-19 period and stimulate growth for recovery — post-Covid.
The fiscal policy interventions include 100 per cent tax relief for persons earning gross monthly income of up to Ksh24,000 ($225), reduction of income tax rate (Pay As You Earn) from 30 per cent to 25 per cent, reduction of the Value Added Tax from 16 per cent to 14 per cent.
The monetary policy interventions include lowering of Central Bank Rate (CBR) to seven per cent from 8.25 per cent).
Kenya’s economic response seems to borrow from Keynesian economics, but with a little tweak. Instead of just increasing government expenditure, the government also wants to stimulate consumers to continue spending by increasing their disposable income.
The government’s response is infused with tenets from Monetarist economics, championed by Milton Freidman. This school of thought maintains that money supply (the total amount of money in an economy) is the chief determinant of GDP in the short run and the price level in the long run.
By lowering the CBR, the Central Bank of Kenya is essentially signalling commercial banks to lower their lending rates. This is intended to avail resources for spending by consumers and investments by businesses. The monetarists rely on quantity of money theory which opines that the nominal value of expenditures in an economy is a function of money supply and velocity (the rate at which money changes hands).
There has not been agreement among economists on whether policymakers should play an active or passive role in economy stimulation.
Those that support the active role argue that leaving the economies to self-adjust is a death sentence which could lead to a complete crash of the economy. Their point of view is that governments should use both fiscal and monetary policy in order to keep the economic output and employment as close as possible to its natural status.
On the flipside, the economists who support a passive role call for a fixed policy rule. Their argument is that interventions through fiscal and monetary policy are opportunistic and inconsistent.
There is also debate among economists about which policy tools are best suited for purposes of economic stabilisation. Typically, monetary policy is the front line of defence against the business cycle.
Among economists, there is widespread disagreement about the extent to which fiscal policy should be used to stimulate the economy in downturns and whether tax cuts or spending increases are the preferred policy tool.
The economic policy tools employed by the government require careful consideration. The policy responses should seek to safeguard and stimulate the micro and macro economy during and after the Covid-19 pandemic.
Joshua Laibon is a manager, Government and Public Sector Unit, PricewaterhouseCoopers Kenya.