Covid-19 and the Day After
Covid-19 and the Day After
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Author : Rachel Poole
Date : January 28, 2021
Here is our take on the articles summarized below:
Central banks around the world have pumped trillions of dollars of liquidity into markets in order to ensure some kind of stability in the face of the Covid-19 pandemic. This “liquidity bazooka” as the Bloomberg article below calls it, has inflated asset prices, creating bubbles in various sectors of the global economy. If central bankers and lawmakers do not tread carefully, the world is at risk of rising volatility that could undermine the recovery. With yesterday’s market downturn, it seems that the 2021 gains have almost disappeared. We can learn some important lessons from the past, including from former Federal Reserve Chairman Paul Volcker, as the world enters a phase of recovery.
Pandemic-Era Central Banking Is Creating Bubbles Everywhere
Enda Curran and Chris Antsey, Bloomberg
The trillions of dollars of liquidity that central banks have been pumping into markets has inflated asset prices and reshaped the way we invest, save, and spend. The massive amounts of liquidity and near-zero interest rates encourages a risk-on attitude, advances speculation, discourages savings, and may lead to a double-dip recession. The risk of particular bloated sectors popping up also exacerbates the risk of financial instability.
There is an obvious disconnect between booming markets and the real economy. Critics of central bankers point out the inequalities being created as central banks stir up markets to new heights but do little for wage gain or job creation. However, monetary policy is limited in what it can do. Central banks, including the US Federal Reserve have said it will be sticking to its loose policies for a while, giving investors an idea of what to expect for the medium-term, a luxury they have not had in past crises. However, if inflation rises, central banks will have to dial back on easing which will create turmoil in the bond markets and could even derail recovery. As chief economist at the Swiss Re Institute in Zurich Jerome Jean Haegeli puts it “Central banks are in a global liquidity trap…The liquidity bazooka buys time and pushes up asset prices but has zero value in improving economic trend growth. Like a black hole, once you are in it, it is extremely difficult to get out.”
Time to Look Again at the Financial System’s Dangerous Faultlines
Paul Tucker, Financial Times
In this article, Paul Tucker argues the March 2020 market drop was a near miss, stretching our financial system to the brink but luckily falling short of another financial crisis. Tucker argues there are three things that need to happen to safeguard stability. First, central banks need to act as market makers of last resort by acting as a backstop buyer and seller to restore liquidity to markets, which is not the same as the current strategy of quantitative easing and buying up bonds. Second, the government bond and bond-lending markets need major repairs. Third, central bankers and regulators must address the mismatch of excessive leverage and liquidity among some types of funds and investment vehicles, also known as shadow banking. After the 2008 financial crisis, plans were made to develop policies for shadow banking but after it was re-labeled the much more positive-sounding “market-based finance”, its issues were pushed down the agenda. Our financial system is less resilient than many people claim. It is critical for central bankers, lawmakers, and democratic leaders to tackle these “dangerous faultlines.”
What is the Economic Cost of Covid-19?
The Economist
The World Bank estimates the world economy shrank by 4.3% in 2020 but this does not account for the economy’s fall from where it could have been had the virus not spread. Before the pandemic, the World Bank expected global GDP to expand by 2.5% in 2020. Compared to this figure, the shortfall from global GDP last year was closer to 6.6%. Furthermore, the level of output for 2021 is expected to remain more than 5% below pre-pandemic projections, bringing the grand cost of Covid-19 this year and last to about $10.3 trillion worth of goods and services which could have been produced if the pandemic had not plagued the world. Needless to say, that we cannot put a value into the hundreds of thousands of lives lost. Unfortunately, the economic damage will not be confined to 2020 and 2021. There will be lasting consequences to investment, human capital, and the growth of the global economy for years to come.
Managing a New Policy Framework: Paul Volcker, the St. Louis Fed, and the 1979-82 War on Inflation
Kevin Kliesen and David Wheelock, St. Louis Fed
Former Fed Chairman Paul Volcker has many accolades to his name, not least of which was his remarkably successful monetarist campaign against inflation in the late 70’s and early 80’s. Volcker’s conviction shaped the Fed’s operating framework into a shape which, though controversial at the time, would preserve the fundamental focus of monetary policy on price stability. When he took the chair in 1979, the Consumer Price Index (CPI) had been rising at a precipitous pace for several years prior, reaching about 15% by 1980. The markets had become highly critical of the Fed’s inability to deal with that inflation, requiring Volcker to first restore the Fed’s credibility. As a pragmatist with a strong dedication to price stability, Volcker began to clamp down on the growth of monetary aggregates to keep the overall money supply in check. Several monetarists (including St. Louis Fed President Lawrence Roos) privately criticized Volcker for not being more adamant on achieving the Fed’s stated growth targets. Volcker would continue to butt heads with Roos throughout his tenure, notably on the importance of controlling interest rates and whether the Fed should be focusing on M1 (highly liquid) or M2 (less liquid) money supply in its policy. Despite a lively debate, both Volcker and Roos saw the need to keep the public informed and educated about the need for the Fed’s aggressive actions, even if those moves came at the cost of short-term flourishing. Although a monetarist approach to Fed policy took a back seat by mid 1980s, the Fed’s role in stabilizing consumer prices remained an enduring legacy of the Volcker era. Nowadays, the Fed has committed to keeping average inflation at 2%. Although he used monetary policy as an effective tool, Volcker was never a pure monetarist; rather, he used monetary policy to achieve his policy goals as a pragmatist.
