International crisis management during the GFC and lessons for the COVID-19 crisis

Lessons from the Global Financial Crisis in the Age of COVID-19

A Virtual Conference co-hosted by the

International Monetary Fund and The University of Tokyo

Tokyo, JAPAN

Session 1: Monday, November 23 

International crisis management during the GFC and lessons for the COVID-19 crisis

Intervention of Francesco Papadia

Senior Fellow at Bruegel

Central bank collaboration was built in Basel, including in the Markets Committee, over the decades against the background of a central bank model built on 5 tenets:

• Even if the Friedmanian approach to monetary policy (control of base money->control of monetary aggregates->control of inflation) has been superseded by the Wicksellian approach (move interest rates higher or lower than the natural rate to control inflation) a tight control of the central bank balance sheet is critical,
• Fiscal and monetary policy should be kept separate and fiscal dominance should be avoided. The FED-Treasury Accord of 1951 and the Banca d’Italia-Tesoro divorce of 1981 were critical steps for effective monetary policy,
• The central bank should concentrate its attention on very short money market rates. The Operation Twist of the FED in 1961 was a failure,
• Resource allocation is no business for the central bank but for the market and, when needed, the government through its fiscal action,
• Similarly, the central bank should not engage into income distribution.

Advanced economies central banks are currently, albeit to different degrees, not respecting any of these tenets:

• Not only balance sheets have grown by a factor of around 10 and 5 and 6 respectively for the FED, the ECB and the BOJ between 2008 and 2020, but central banks have shown willingness to let other agents determine the size of their balance sheet. For instance, the ECB with its huge refinancing operations, lets banks influence the size of its balance sheet, while the FED, with the swaps, allows foreign central banks to do the same. And the interest rate is now complemented or even substituted as tool by QE;
• While institutionally monetary policy and fiscal policy are separate and there is no fiscal dominance, with central banks in the US and the euro-area holding between close to 30% of the stock of government bonds and Japan holding about a half of it there is, de facto, no separation possible. It used to be the case that central bankers implored governments to carry out prudent fiscal policies. Now they beg for fiscal easing;
• Yield curve control is formally pursued by the BoJ, but various forms of QE in the US, euro area, and the United Kingdom de facto pursue a very similar goal;
• Targeted refinancing operations in the euro-area explicitly favours bank lending to enterprises rather than to households, 13.3 operations from the FED clearly have resource allocation purposes;
• Income distribution has clearly entered among the considerations of central banks, albeit in a soft way. The ECB has been busy to show that its monetary policy, by reducing unemployment, has more than offset the effect income distribution because of the impact of QE on asset prices. The FED strongly emphasizes, including in its strategy review, the effect on the income of marginal workers from keeping unemployment low.

In some ways, what central banks are currently doing looks suspiciously similar to the prescriptions of the derisory Modern Monetary Theory. My personal problem is that I live the inconsistency of being still attached to the 5 tenets and thinking MMT is fallacious, while also basically supporting what central banks in advanced economies are currently doing.  

The only way to get out of my internal inconsistency is to think that we are seeing a temporary deviation from the 5 tenets because of the double hit on the global economy, first from the Financial crisis and now from COVID. This is my understanding of the view of Bartsch, Boivin, Fischer, and Hildebrand, who propose a temporary and central-bank-controlled deviation from the 5 tenets. Of course the word “temporary” is one that allows a lot of flexibility, but starting in 2007 it is already 13 years that we are in a temporary situation and it is not clear that, if this lasts very long, central banks will indeed be able to control it and call an end to it when needed.

The issue most relevant for todays discussion about central bank collaboration is whether this has become more difficult because of the new model that central banks are de facto adopting.

There is, in my view, no definitive answer to this question but a number of concerns can be mentioned, some more technical and others more political.

First, the move from the sole concentration on the short interest rate as a tool to the emphasis on QE makes collaboration more complicated. When, in October 2008, six central banks, including the FED and the ECB, reduced interest rates by 50 BP to deal with the consequences of the financial crisis, there was no doubt that they had taken a broadly comparable measure.  Achieving such a result for outright purchases under a QE operation would be very difficult, if not impossible: would purchases of 100 billion in the US be really comparable to purchases of 100 billion in the euro-area?

Second, the linkages between fiscal and monetary policy inevitably give a national character to monetary policy, which is therefore more difficult to organize in a collaborative mode. In my assessment, private market participants naturally take an international perspective while governments are more linked to a national one. Central banks occupy an intermediate position between the two, but their closer link to governments push them away from taking an international perspective. A more worried way to look at this issue is to consider that gthe link between monetary and fiscal policy can affect central bank independence, including  their ability to collaborate internationally.

Third, I also believe that taking into account resource allocation and income distribution issues, with all their national idiosyncrasies, tends to move central banks towards a more national approach.

Fourth, looking from outside I don’t see bursts of collaboration in dealing with COVID 19 like the ones that appeared during the Great recession: the joint reduction of interest rates and the establishment of, in principle unlimited, swaps.

Fifth, as noticed in the note the organizers prepared for the conference, the move of some governments and, more generally, of public opinion towards nationalist attitudes establishes a negative background for central bank collaboration.

Let me hasten to say that the renewal of the swap network in 2020 should allay the fear that central banks are less ready to engage into concrete collaboration. Indeed, I was favourably impressed by the ability of the FED not to be constrained by the nationalist tone coming from the US President. And, while not observing meeting in Basel anymore, I hope that there the collaborative spirit is still prevailing.

At the end, I am afraid I don’t have a final view on whether central bank collaboration is more or less difficult with the now prevailing central bank model. I firmly believe, however that, first, central bank collaboration is as needed as always and, second, that we should keep a very keen eye on developments in this area, ready to detect, and possibly counter, deviations from the collaborative behaviour.