Over the past two decades or so, central banks around the world have played a more pivotal role in shaping the economy as the fiscal space in many Western economies has been constrained by high debt burdens.
Back when the global financial crisis was unfolding in 2008, Ben Bernanke, the then-chair of the U.S. Federal Reserve, rolled out non-traditional policies including massive asset purchases – aka “quantitative easing” or QE – and ultra-low interest rates to bolster financial market conditions and the broader economy. Mario Draghi, his counterpart at the European Central Bank (ECB), took a similar approach, and made a promise at the height of the eurozone sovereign debt crisis in 2012 to do “whatever it takes” to save the euro.
Ironically, stock markets sometimes respond negatively to positive economic data, as investors fear that central banks might remove the huge liquidity injected through QE, or raise interest rates faster. By the same token, they can react positively to poor economic data in the hope that more will be done to prop up the market.
Press conferences that take place immediately after central banks’ policy decisions have often become headline news in recent years, with commentators seeking clues on what central banks are likely to do (or not do) next. In the United States, the voting record of every Fed governor is put under a microscope. Some commentators have referred this phenomenon as the age of the “rock star” central bankers, compared with calmer times when the dictum that “good central banking should be boring” applies.
The Covid-19 pandemic may prove to be a watershed moment for the policymaking arena. Firstly, unlike many economic shocks, which mostly affect the demand side, the coronavirus, at least during its initial stage, caused significant disruptions to the supply side when cities were in lockdown, and factories and borders are closed.
Accordingly, monetary stimulus – for instance, by injecting liquidity into the financial markets – is not that effective in responding to such a supply-led economic crisis. In this regard, public health advisers may be more influential than central bankers, as they play a role in the formulation process of nations’ lockdown strategies.
Secondly, there has been limited room for major central banks to ease monetary policy further by reducing interest rates, given they were already at rock-bottom levels before the pandemic. Although the Fed began to normalize interest rates gradually in late 2015 (before reversing course in 2019 in the face of uncertainty amid the Sino-U.S. trade war), the Fed funds rate has remained low by historical standards. Meanwhile, the ECB has kept its main interest rate at zero since 2016.
Recognizing the limitations of monetary policy and amid growing calls for swift action, finance ministers and their fiscal policies have been taking a more prominent role during this coronavirus-led recession.
The low interest rate environment and the expectation that it will likely remain for a prolonged period of time have generally provided governments with a bigger capacity to borrow without provoking alarms regarding public finance sustainability. This is under the assumption that economic growth should be able to cover the interest on debt in the near future. Some economists even believe that the issuance of debt to fight the coronavirus recession without the need for future increase in taxes might be feasible.
The International Monetary Fund estimates that economies across the globe have spent a total of US$12 trillion as of mid-September 2020, or some 12% of global GDP, on fiscal actions. These consist of additional spending, tax cuts and liquidity support through loans and guarantees. Accordingly, government deficits are expected to increase by an average of 9% of GDP, and global public debt to approach a record high of 100% of GDP.
In Hong Kong, which has accumulated ample fiscal reserves over the years, the introduction of a basket of relief measures has amounted to over HK$300 billion, equivalent to 11% of GDP or HK$40,000 per capita.
In spite of the high levels of debt worldwide, the IMF has called for more fiscal support, stressing that the near-term priority is to avoid premature withdrawal of the stimulus.
Given these factors, it seems highly likely that the economic role of governments will become bigger globally, compared to the pre-Covid era, in the years – or even decades – to come.
The questions now emerging are: at what point on the economic spectrum the balance should rest and, for now, how to formulate more targeted responses to ensure that the money is spent to support those most in need. While an increase in public spending during rainy days faces little opposition, governments may find it difficult to reverse this course when better times arrive.
The very lesson that we have learnt from Covid-19 is that a crisis – even one with an extremely low probability of occurring – can erupt all of a sudden. The pandemic and a low interest rate environment together have shifted policymaking towards fiscal activism, but it is important for governments to resist the temptation to borrow excessively. The coronavirus may not be the last major crisis of our times.
Wilson Chong, firstname.lastname@example.org