As the coronavirus pandemic continues, Bloomberg Opinion will be running features by our columnists that consider the long-term consequences of the crisis. This column is part of a package on monetary policy.
Just a few weeks into the coronavirus pandemic, the world’s most powerful central banks have found themselves shoved violently back into crisis-management mode. How they emerge from this latest emergency — and how it affects their political autonomy, mandates and credibility — is less a function of what they do and more of what happens around them.
After a golden age in which central banks were feted for vanquishing inflation, and sometimes even for taming the vagaries of the business cycle, they found their reputations tarnished by the financial crisis of 2008 and the recession that followed. An aggressive “whatever it takes” policy helped them to eventually win that war. But the prolonged and excessive reliance on them that followed — a result of the failure of most advanced countries to pivot to a more comprehensive policy response — failed to secure the peace.
In this latest crisis, which is likely to be a generation-defining one, central banks have now gone “all in,” deploying emergency interventions in record time that have already exceeded the steps they took during the financial crisis and its aftermath. What they’ve done is truly stunning. It has included flooring interest rates, embarking on massive securities-buying programs, reopening emergency financing windows and creating new ones.
The magnitude of this response is likewise unprecedented. The Federal Reserve has now expanded its balance sheet beyond $6 trillion, an increase of almost $2 trillion in less than a month. It has taken extraordinary steps to lift regulations to help banks play their part in the relief effort. It’s also still working closely with the U.S. Treasury — and, in the process, venturing into areas that were once deemed verboten, both for the risks involved and the potential for serious mission drift.
As the old saying goes, no good deed goes unpunished. And as welcome as these aggressive new interventions have been in containing already severe economic damage, there’s no denying the costs and risks that come with them. These are not just economic and financial risks, but institutional and political as well.
Consider the following:
By taking on its balance sheet more exposure to different segments of the economy, both directly and in partnership with the Treasury, the Fed is exposing itself to risks that go well beyond what it can influence directly. This includes the extreme credit risk that comes from defaults and bankruptcies.
By rushing in with “massive bazookas” to support markets, central banks may again inadvertently contribute to investor behaviors that have consistently decoupled asset valuations from underlying fundamentals. Already, the stock market has soared in response to the Fed’s enhanced activism. The result is continued under-appreciation of liquidity risks, deeper unhealthy co-dependency between central banks and markets — and, with that, an increased risk of financial instability down the road.
Being forced into crisis-management mode, and making so many decisions amid the “fog of war,” means not just that the chance of central banks making mistakes is inherently high but also that the likelihood of Monday-morning quarterbacking is considerable.
By attracting so much attention to the trillions of dollars that it is deploying to avoid market failures, the Fed has again opened itself to the accusation that it has been co-opted by the financial sector. At the same time, a more damaging and unfair view is already circulating on social media: that the central bank cares more about the wealth of the 1% than the wellbeing of the population as a whole.
More political actors, including relatively new lawmakers in Congress, are being exposed to the considerable power and resources of central banks — this at a time when many more elements of so-called Modern Monetary Theory are becoming realities on the ground. With that, the pressure on the Fed to embark on a “people’s QE” or some similar program is likely to increase significantly.
These risks will multiply the longer it takes to restart the economy. The more durable the shutdown, the higher the threat that liquidity problems become solvency ones, and the more likely that bankruptcies and defaults proliferate and raise questions about the Fed’s judgment and competence. That could also lead to renewed market volatility at a time when the Fed is putting massive resources on the line — and, with them, its credibility.
Unfortunately, these challenges won’t end once this exceptional period of crisis-management subsides. They’ll also extend to the next two stages: the economic restart and the post-crisis policy landscape.
It’s increasingly clear that the economic reopening may not be as immediate — or as generalized — as we would all hope. The growing likelihood of a sequential restart of both national and global economies will raise a new set of challenges for central banks and governments, companies and households.
After that, we’ll need to navigate a landscape that involves more than simply disentangling what is quickly evolving into a spaghetti bowl of public-sector involvement in private-sector activities. We could also be facing an environment of more sluggish supply and demand responsiveness.
With an expected shift in corporate emphasis from efficiency to resilience, we should anticipate that many global companies will revisit their supply chains, even if it means sacrificing cost-effectiveness and just-in-time inventory management. This rewiring, while not instantaneous, will accelerate existing trends toward deglobalization, which have been driven by concerns for the marginalized, trade wars and the weaponization of economic tools.
At least in the short-term, all this will involve a decline in productivity accentuated by a higher risk of “zombie companies” due to the immense financial subsidies now being provided by governments and central banks. Meanwhile, corporate indebtedness continues to rise, as does government debt. Both trends may end up putting pressure on the Fed to resist interest-rate increases in the years ahead.
Turning to the demand side, households may well become more risk averse. To the extent they do, they’ll prove less responsive to the stimulus policies that will follow the current phase of relief. And the longer the crisis stage lasts and the harder the restart phase, the higher the possibility of a recurrence of a more frugal “great depression generation.” This would be especially likely if economies were inadvertently pushed into a “W”-shaped recovery — that is, a repeat of the lockdown-restart cycle, due to a resurgence of health concerns.
It’s important to stress that the optimal central bank response to all these uncertainties is not paralysis. Rather, it is to continue with intense work on scenario analyses, internal and external communications, contingency planning, feedback and mid-course adjustments as needed. To avoid repeating the errors of the financial crisis, these efforts will need to be supported by a “whole of government” approach that combines stimulus with a range of structural reforms aimed to counter the downward pressure on productivity and growth potential.
Otherwise, central banks may once again help to win the war against a depression, but be part of a system that fails to win the peace of durable and inclusive growth.
Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include 'The Only Game in Town' and 'When Markets Collide.'
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