Beyond the Lockdown: Monetary Policy and Financial Stability in the Transition
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On June 9, the Global Risk Institute (GRI) hosted a webinar with William White, who is Senior Fellow, C.D. Howe Institute, and former Chairman, OECD Economic and Development Review Committee. The webinar was hosted by James (Jason) Stewart, Executive in Residence, and moderated by Vanda Vicars, Chief Operating Officer, GRI.
Mr. White began his presentation by looking back on monetary policy in the advanced economies leading up to and since the financial crisis of 2008.
One of the themes, he said, has been how politicians have had many opportunities to make hard choices in the past and over decades have refused to do so. Every time there has been a problem, the answer to that problem has been easier fiscal policy and a growing reliance on central banks to provide easier monetary policy. This was then followed by an unwillingness to belt-tighten symmetrically during the subsequent upturns in the economy. The upshot of this has been a consistent increase in debt, both public and private, over time and a ratcheting down of interest rates in successive cycles. “And now we have the pandemic, which is debt accumulation on steroids,” he noted.
Mr. White said the question we have to ask today is whether the time has at last come to start making some hard choices. To have an informed discussion, he said we need to understand three issues: how the world got into this debt overhang problem; what type of new world we might want to move towards; and what type of opportunities for change the pandemic crisis might present.
Mr. White said the monetary crisis of 2008 was basically a bust after a credit- boom- cycle of the sort we have seen repeatedly in history. He said three factors led up to the bust, each of which alone was not bad, but together led to the financial crisis. The first was a positive supply side shock due to demographics (increased production by Baby Boomers) and the fall of the Berlin Wall (expansion of global supply chains). These developments contributed strongly to global disinflation.
The second factor was the response of the central banks to this disinflationary trend. Because inflation was never a problem, central banks were able to resist downturns strongly through monetary stimulus and to avoid having to raise interest rates during upturns. Easy monetary conditions increased the demand for credit. A third and compounding factor leading up to 2018 was the degree of financial innovation in advanced market economies, including subprime debt and market-backed securities. This led to a big supply of credit to meet the increased demand. It was “an accident waiting to happen” and the policymakers all missed it.
In a fundamental sense, explained Mr. White, what has happened since 2008 is more of the same. And it was based on the same two false beliefs that characterized the pre crisis period.
The first false belief was that monetary stimulus would always be effective in increasing overall demand. Unfortunately, this kind of stimulus just brings spending forward, which only works for a limited time. And it increases debt, which eventually restrains spending. By 2008, both of these “headwinds” had become gale force winds.
The second false belief was that stimulus would have no harmful side effects. However, we now have global debt as a percentage of GDP that is much higher than in 2008, and this time the worrisome growth in debt has spread to include emerging markets. In addition, financial stability is being threatened by weaker financial institutions (e.g. margins squeezed, appetite for higher risk) and by badly functioning financial markets (e.g. mispriced assets, markets that fail to function, the Fed‘s loss of control over short-term money markets). Slower potential growth caused by capital misallocation has been another harmful side effect.
The result of all this, said Mr. White, is that we had an unsustainable economy even before the pandemic hit. In effect, the patient had dangerous preconditions.
While the present downturn is unique in that it was triggered by the government-imposed lockdown, the unprecedented policy response supports a near-term bounce back. But not all of the rebound is justified by the underlying economic fundamentals. Longer-term “headwinds” will restrain both demand and supply, as will recurrent waves of the virus without a vaccine or treatment. This presents both political and financial risks. In short, “Where we are is essentially non-sustainable.”
So the next question is “where do we want to go to have a sustainable world?”
Mr. White said that we need to have an analytical revolution where we think about the financial, economic social, political and environmental aspects of the world in a different way than we did before. This particularly applies in the economic and financial realm. We have got to embrace the concept that the economy is a complex, adaptive system like so many others in nature and society. In addition, the sustainable world that we wish to move towards will have to be both more inclusive and more respectful of environmental limits like global warming.
How do we get there from here, the current state of the world? Mr. White said there is a way forward.
He explained that we need to build more resilience into our production systems. However, more resilience means less efficiency, which will be costly. Debt restructuring will also be required which requires creditors to write down asset values. Mitigation of environmental changes will be costly as will adaptation to such changes. Workers will need a better deal to avoid ongoing social and political unrest. The challenge will be how to convince everyone of the need for profound change, when those changes seem so costly. In effect, people must come to accept that solutions that are “unpalatable” are preferable to outcomes that are “disastrous”
In the post-pandemic environment, he concluded, dealing with the debt overhang will remain a pivotal issue. There are solutions, but all of them are difficult. Austerity can only go so far before it makes things worse (the paradox of thrift). Relying on a spontaneous increase in real growth, reducing the burden of debt service, is challenged by debt headwinds, and also requires a lot of good luck.
Fiscal expansion supported by financial repression (if financial markets are prepared to have enough patience with rising government debt) might just work to support faster growth. Should inflation also rise to moderate levels, that too might help reduce the burden of outstanding debt. Of course, to have this latter effect, interest rates must be prevented from rising along with the expectations of higher inflation. While governments succeeded in doing this after WW2, the question is whether financial repression of this sort would be possible in the modern world? The principal danger arising from this strategy is that inflation might suddenly rise to very high levels as economic agents began to worry about a growing government reliance on central bank financing.
Mr. White finished his presentation by repeating that, while restructuring debt is unpalatable for investors and lenders, in the end it might be that accepting some limited losses beats the alternatives.
Senior Fellow, C.D. Howe Institute
Former Chairman, OECD Economic and Development Review Committee
William R. White is currently a Senior Fellow at the C.D. Howe Institute in Toronto, Canada. Until April of 2018 he was the chairman of the Economic and Development Review Committee at the OECD in Paris. This committee carries on regular evaluations of the policies of both member countries and aspiring members of the OECD. In his capacity as chairman, to which he was appointed in October 2009, William White also contributed to meetings of WP1 and the Economic Policy Committee of the OECD. As well, he was for four years a member of the Issing Committee, advising the German chancellor on G-20 issues. William White has in recent years published many articles on topics related to monetary and financial stability as well as the process of international cooperation in these areas. He speaks regularly to a wide range of audiences. Mr White was presented in September with the 2016 “Adam Smith Prize”, the highest award of the National Association of Business Economists (US). In May of 2015 he was honoured with the “Hans-Moller-Medal” from VAC, the alumni club of political economists at Ludwig-Maximilian University of Munich. Prior to that, he received the annual “Prize of the Monetary Workshop in Monetary, Financial and Macro-Prudential Policy “in Frankfurt in May 2014. Mr White joined the Bank for International Settlements in June 1994 as Manager in the Monetary and Economic Department, and was appointed to the position of Economic Adviser and Head of the Monetary and Economic Department (MED), in May 1995. He oversaw the preparation of the prestigious BIS Annual Report for which he wrote the Introduction and Conclusions. As Head of the MED, he had overall responsibility for the department’s output of research, data and information services, and the organisation of meetings for central bank Governors and staff around the world. Mr White was also a member of the Executive Committee which manages the BIS. In this capacity, he contributed actively to various internal subcommittees which establish policies to guide the Bank’s overall activities, including those of the Banking Department and Risk Control. He retired from the BIS on 30 June, 2008. Mr White began his professional career at the Bank of England, where he was an economist from 1969 to 1972. Subsequently he spent 22 years with the Bank of Canada. His first six years at the Bank of Canada were with the Department of Banking and Financial Analysis, first as an economist and finally as Deputy Chief. In1978, Mr White took on different responsibilities as the Deputy Chief of the Research Department and was made Chief of the Department in 1979. He was appointed Adviser to the Governor in 1984 and Deputy Governor of the Bank of Canada in September 1988. In addition to these permanent positions, Mr White spent six months (1985- 86) as a Special Adviser to the Canadian Minister of Finance and six years as a member of Statistics Canada’s Advisory Panel on the National Income Accounts. Since the late 1980s, he has been an active participant in many international committees, including the EPC and WP3 at the OECD, the G-10 Deputies, and the Bellagio Group which brings together senior government officials, central bankers and academics. Born in Kenora, Ontario, Mr White received hs BA from the University of Windsor in Windsor,Canada. In 1969 he rceived his PhD from the University of Manchester, UK, where he was supported by a Commonwealth Scholarship.