The Big Picture: Economic Policy Lessons for 2023
There was a different social and financial and economic life before the pandemic. Blurred together with that was another great dividing line in the history and functioning of the global financial system, a before and an after the events of 2008-2009.
Late this year, the Yale University Program on Financial Stability published an occasional working paper for the G30. The paper was an edited roundtable amongst five of the most distinguished current and past policy leaders.
The roundtable was moderated by Timothy Geithner, former US secretary of the Treasury:
- Ben S. Bernanke, former Chairman of the US Federal Reserve Bank
- Agustín Carstens, Secretary General of the Bank for International Settlements
- Tharman Shanmugaratnam, Senior Minister and Coordinating Minister for Social Policies, Singapore
- Masaaki Shirakawa, former Governor of the Bank of Japan
Each addressed different policy questions, summarized below in the words of the author of this opinion. WAIFC member organizations are navigating these very strong currents, whose force and effects will be continuing to affect their work in the years to come.
Financial markets suffered a brief, severe panic in March 2020, a dash for cash with high volatility as treasuries and then other securities were sold. As in 2008, many sellers were from the shadow banking system, such as relative value hedge funds. Bond funds and money market funds were heavy sellers, because they had promised daily liquidity. Banks were actually rather liquid, but they found themselves having to meet pre-committed credit lines in full. Then foreign government began to sell treasuries in order to provide dollars for their own domestic financial systems and to support their own currencies.
The main buyers were securities dealers. Clearly, there was a massive market imbalance.
The Fed responded in three ways. First, it used the discount window to serve as the lender of last resort to US financial institutions. It reopened the primary dealer credit facility, and reinstated the 14 currency swap facilities with other central banks – which basically allowed foreign central bankers to serve as lender of last resort in dollars to the institutions they oversaw. The Fed has kept these facilities as a permanent tool.
Second, the Fed became the buyer of last resort for treasuries and mortgage-based securities that were pouring into the market. The Fed publicly stood ready to be that buyer, as it had done in 2008. The Fed may have ended up buying far more of those securities than it initially thought it would.
The third step was possibly the most radical: as credit markets froze, the Fed became a lender of last resort to non-financial firms, as it had done in 2008 via the commercial paper markets. It went on to buy corporate and municipal bonds. It then worked via the banking system to lend to medium-sized, ordinary, nonfinancial companies – the Main Street facility, which was unheard of.
Regulatory relief also came into play, the easing of the supplementary leverage ratio that allowed banks to hold treasury and reserves without holding capital behind them.
In addition to the moral hazard of massive central bank intervention, Mr Bernacke offered some particular points that merit consideration. The first is why would public bond funds offer daily liquidity for their management of long-term securities? The second is what to do with shadow banking, and its corrosive effect on broader public oversight of the financial system?
The Covid “sudden stop” makes for a remarkable policy study, given that it led to the steepest contraction in global economic activity in living memory. Mr. Carstens chose to consider the aftermath, the problems occurring after economic growth returned.
The inflation risk must be assessed in terms of what may be transitory and what may be leading to generalized price increases. Expectations must be well-anchored.
Corporate sector insolvencies is another major risk as support has been withdrawn: furlough schemes, debt moratoria, government guarantees, and very low interest rates must end. At the same time, policy-makers have to consider the considerable increase in corporate debt levels; and to that end, the banking sector must be prepared to roll over loans to viable firms. For firms which cannot emerge into this new environment, policymakers must immediately review law and regulation to assure quick and efficient winding down of those businesses.
Another matter is that the economy is recovering at very different speeds around the world.
Reflecting back, it is clear that the interactions between fiscal, monetary, and prudential regulation were more intense than might have been appreciated by the actors involved. Government borrowing costs fell due to lower central bank rates, and this was in turn transmitted to the broad economy through loan guarantee programs. Prudential supervisors lowered the leverage ratios, which took pressure off bank reserves. In turn, the Basel III bank reforms had already led to a more resilient banking sector then better able to continue to provide loans and other key services to households and enterprises.
A key problem ahead will be for central banks to unwind their massive balance sheets, which have been multiplied beyond any historical trendline relative to GDP except in wartime. Public debt has hit a post-World War II peak.
Timing for the progressive return to some sort of pre-Covid “normal” monetary and fiscal policies will be delicate. Too rapid fiscal consolidation would restrain growth, but too rapid increases in interest rates could force governments to withdraw their support too early, given the interest costs. If unconventional central bank practices continue longer, this may encourage higher leverage and more risk-taking; some prudential policies were relaxed during Covid, but this step could undermine the banking sector’s resilience over time.
Solutions would include policies that encourage higher sustained growth. Structural reforms have been flagging for some years, and for many good reasons they need to be addressed. Particularly for the banking sector, macroprudential countercyclical buffers are important during good times to rebuild accumulated capital for proper risk management in a moment of tension that would not call on the public purse. Banks would be positioned to continue to offer credit. Finally, over the 15-year period, non-bank financial institutions have grown in scale, and their resilience must be assured through proper regulation.
Among the great risks Mr. Shanmugaratnam would draw attention to is the neglect of the global commons, as showed up in the pandemic as well as in climate change, the one erupting quickly and the other a slow burning problem. These and other forms of shocks will keep on coming. There is a pattern to these events, and our policy responses will have major economic, financial, social, and political consequences.
The lack of coherent response to this pattern is already causing a rollback in the long and vital process of convergence between the developing world and societies that are wealthier. That trajectory has already been modified.
The loss of an entire school year world-wide will have long-term consequences. We see climate shocks for crop productivity, for livestock farming, and as a vector for water-borne diseases. Less tangible but more pernicious is the lost of trust we are seeing within societies and across countries, which will make it all the harder to begin to care better for the global commons.
What is required is a rethinking and reorientation of international cooperation. Existing institutions can be repurposed; the question is fundamentally a matter of how we invest in global public goods, the sorts of investments that need to be targeted, as well as how we go about executing policy. In addition to the evident moral benefit, this is ultimately in the national interest of every country. The commons is where national self-interest and international solidarity come together.
Private wealth is not enough to change back the trajectory of neglect: the world needs a strong layer of public multilateral funding, based on pre-agreed contributions. The actual cost need not be that high: Mr. Shanmugaratnam chaired an assessment for G20 on international pandemic security, and the estimate need was on the order of $ 15 bn. That cost would have been far lower than the one the global economy incurred.
The World Bank and IMF need to put the global commons at the heart of their mandates. Rather than waiting for the bottom to fall out under many countries, even recognizing that change in our reality just might refocus the attention needed. Also, multilateral development banks must join in incentivizing governments to do their part to make sure there is better crisis response preparedness.
As the very term “global commons” indicates, this is the entire world’s pressing interest.
The global recession due to Covid ended more quickly than feared, and the recovery occurred generally faster, too. Why was this?
What contributed most was the relatively successful vaccination program. He posited as the second factor the point that the downgrading of globalization did not occur as quickly or as exstensively as many feared at the height of the Covid crisis.
In finance, the US dollars supplied to other central banks was the first element of success. Second was the Fed’s support to the US treasury market. Third, governments and central banks stepped forward to support business, and fiscal policy measures targeted at income compensation for individuals and firms kept the economy running.
What is less clear to Mr. Shirakawa is how effective monetary easing was – lower interest rates might have kept more people circulating extensively, and therefore more virus with them. That was hardly the public health objective. This may have to be studied.
What is more troublesome is the thought that central banks have to be called in to rescue economies each time they get into various troubles, and the same is true for government issuance of increasing amounts of debt. This reflex to lower interest rates and issue more government debt actually erodes economic resilience over time.
Broadly speaking, over the last several decades has the public policy response in fact increased the probability of future macroeconomic crises? Sustainability is being undermined by the build-up of financial imbalances, such as elevated asset prices. Trust is being eroded by the inequality of wealth distribution across our societies. The only partial alleviation of income equality that a central bank can provide is expansionary monetary policy, but this also worsens other economic and social problems – monetary easing frontloads future demand, and over time productive investment declines.
The choices made in 2008-2009 and again during the Covid pandemic have massive consequences for financial services in 2023 and beyond. The measures taken – and those not taken – set the context for WAIFC members’ work.