The threats to recovery


Over the past year, rich-country governments and central banks have provided unprecedented fiscal and monetary stimulus to help mitigate the economic impact of the COVID-19 pandemic. Getting back to economic normalcy – whatever modified form that takes in 2021 and 2022 – will require advanced economies to start weaning themselves off official support before too long, and thereby avoid dangerous new complications.

On the monetary-policy front, central banks around the world did whatever was necessary to calm financial markets when the pandemic struck in the spring of 2020. They have since maintained a highly supportive stance, with historically low and in some cases negative real policy rates. Monetary policymakers reused and enlarged existing tools, and fashioned new ones as needed.

These crucial efforts have greatly inflated major central banks’ balance sheets. In December 2020, the combined assets of the US Federal Reserve, the European Central Bank, the Bank of Japan, and the People’s Bank of China stood at a staggering $28.6 trillion. The ECB accounted for $8.5 trillion of this total, and the Fed $7.3 trillion, while the BOJ and the PBOC had total assets of $6.8 trillion and $5.9 trillion, respectively.

Likewise, advanced-economy governments have pursued historically aggressive fiscal policies, casting aside spending restraints to provide broad and largely indiscriminate support to many who needed and deserved it. The Group of Thirty estimates that direct fiscal support for firms, employees, and the unemployed during the COVID-19 crisis now exceeds $12 trillion globally. That assistance, supported by a broad political consensus, has prevented a great depression and widespread hardship.

Many of these emergency measures were necessary and unavoidable. But as policymakers eye a possible recovery in 2021-22, they must be vigilant about the side effects of prolonged monetary and fiscal stimulus. The United States and other rich countries face several risks as they try to rehabilitate and refashion their economies.

For starters, the current equity high could quickly turn into a nasty headache as policy stimulus fades. Equities have been on a tear, fueled by huge liquidity flows and easy money, with yield-hungry investors piling into risk assets.

Moreover, markets implicitly understand that central banks currently stand behind most asset classes, elevating risk tolerance. This helps to explain the recent run-up, wobbly retreat, and subsequent rebound for Bitcoin, and the social media-driven surge that squeezed hedge funds that had been short-selling the retailer GameStop. And the craze for special-purpose acquisition companies (SPACs), which raise capital through an initial public offering and then look for private firms to buy, continues unabated.

But it is doubtful that the current equity boom and search for yield can be sustained if policymakers withdraw monetary and fiscal stimulus. The resulting market correction may be sharp and painful, and many investors will pay a heavy price.

A second risk relates to corporate pain. The extent of state support until now has kept business-closure and bankruptcy rates lower than normal in most advanced economies. But as governments and central banks dial back support, as they must, the process of creative destruction will resume among small- and medium-size companies, and even some bigger firms.

Many struggling firms currently being kept afloat by government largesse will not be solvent and sustainable in the post-pandemic economy. Policymakers need to allow them to go bankrupt, be taken over, or close. Recognizing this and allowing normal market processes to play out will hurt many companies and employees, and saddle banks with non-performing loans. But economies will have to stand the pain, because there is no alternative.

A third danger is that other sources of infection – which central bankers and supervisors may be ill-prepared to tackle – trigger a new economic contagion. For example, risks may come from the massive and growing shadow banking sector, which the Financial Stability Board estimates had financial assets in 2018 of $50.9 trillion, equivalent to 13.6% of the global total.

Other threats to economic stability abound, from cyberattacks and artificial-intelligence failures to bond-market stresses and sovereign-debt defaults. As economies recover from the pandemic, central bankers and regulators cannot afford to discount emerging new risks in unsupervised financial markets and technologies, or relax their vigilance in supervised sectors.

Lastly, there is the danger of relapse. If we fail to inoculate fully populations outside the core advanced economies against the coronavirus, we risk allowing unvaccinated groups to incubate new strains, leading to new COVID-19 surges. Vaccinating the world to avert this scenario would cost an estimated $38 billion – a negligible price to pay for fostering a robust global economic recovery. Rich countries must make the necessary funds available and stop hoarding vaccines.

Faced with these risks, policymakers in the advanced economies must be mindful of the side effects of their aggressive monetary and fiscal measures. Their task will be even harder if G20 governments – led by the US – fail to commit the modest resources needed to inoculate the world against COVID-19. We simply cannot afford repeated relapses, pandemic surges, and economic standstills.

William R. Rhodes, a former Chairman, CEO, and President of Citibank, is President and CEO of William R. Rhodes Global Advisors, LLC and author of Banker to the World: Leadership Lessons from the Front Lines of Global Finance. Stuart P.M. Mackintosh is Executive Director of the Group of Thirty.

Copyright: Project Syndicate, 2021.

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