Hyun Song Shin On What Central Banks Have Learned From The Crisis

Podcast Summary

• A Unique Economic Downturn: Policy-Induced and Global in Scope: This economic downturn is unique due to its policy-induced nature and global impact, requiring a comprehensive response from central banks and experts.

  The economic downturn we're experiencing is unique due to its policy-induced nature. The recession is unlike anything we've seen before, with a significant economic contraction that's eclipsed previous crises. Central banks have responded with unprecedented policy measures to support the economy during this health crisis and resulting lockdowns. Hyun Seung Shin, the economic advisor and head of research at the Bank for International Settlements, highlights this defining moment for the global economy. The pandemic not only brought a health crisis but also an economic standstill. The policy response has been massive, addressing both the health crisis and the economic downturn. It's a situation unlike any other, requiring a 360-degree perspective and global expertise to navigate the complexities. For more insights, visit principalam.com or listen to the Visibility Gap podcast presented by Cigna Healthcare. Investing involves risk, including possible loss of principal.

• Central banks tackled liquidity issues effectively but needed new tools for solvency: Central banks adapted to the unique challenges of the current crisis by using crisis-era tools for liquidity, but must continue innovating to address solvency issues, possibly through collaboration with fiscal authorities and exploring new monetary policy tools.

  While central banks were able to effectively address liquidity issues during the current economic crisis through the use of tools developed during the 2008 financial crisis, the unique nature of this crisis, which primarily affected ordinary individuals and small businesses, required new innovations to address solvency issues. Central banks have more direct levers to alleviate stress in the banking sector, but fewer tools to reach those most acutely affected by the crisis. The acute phase of the crisis is now coming to an end, but the challenge for central banks moving forward is to continue innovating to effectively address solvency issues. This may involve collaborating more closely with fiscal authorities and exploring new tools beyond those traditionally used in monetary policy.

• Central banks' role in economic crises: Providing liquidity and stabilizing markets: Central banks provide relief during economic crises by addressing liquidity issues and stabilizing markets. Fiscal authorities take over to distribute resources effectively as the situation evolves, with unprecedented budgetary measures totaling up to 22% of GDP. Central bank independence now focuses on quick action while politics deliberate.

  During times of economic crisis, both monetary and fiscal measures play crucial roles in providing relief and support. Central banks, through their ability to implement swift policies, have been instrumental in addressing liquidity issues and stabilizing financial markets. However, as the economic situation evolves, the focus shifts towards fiscal authorities to distribute resources effectively to those in need. The speed and size of fiscal packages have been unprecedented, with advanced economies announcing budgetary measures totaling up to 22% of their GDP. Central bank independence, once synonymous with the ability to fight inflation independently of political pressure, now primarily refers to an institution's ability to act quickly while politics deliberate. The success of central banks during this crisis can be attributed to their technical expertise and their position outside of day-to-day political processes.

• Central banks balancing monetary policy and fiscal collaboration: Central banks must prioritize monetary objectives while collaborating with fiscal authorities. Acceptable interventions include stress relief measures, but aim for eventual disengagement.

  Central banks, as independent institutions, should maintain their focus on monetary policy objectives while collaborating with fiscal authorities. The speed and flexibility of central banks in the financial markets are essential for stress relief, but it's crucial they don't subordinate their monetary policy goals to fiscal objectives. Central banks buying securities in the secondary market for financial stability reasons is acceptable, as long as they aim for eventual disengagement. The distinction lies in the intention behind the intervention. For instance, during the March panic, central banks' massive interventions, like the Fed's corporate bond market backstopping, were necessary to preserve financial stability and prevent a corporate system run. However, the long-term economic consequences are uncertain, and it remains to be seen if fiscal authorities will support creditors effectively.

• A new type of financial crisis emerged in 2020: The 2020 financial crisis differed from 2008, focusing on marketplace stress instead of banking issues. Emerging markets showed resilience, and classic Fed interventions helped. Foreign investors continue to invest in local currencies despite holding large debt.

  The financial crisis in 2020 was different from the one in 2008, with the stress primarily in the marketplace system rather than the banking system. The initial phase was addressed through classic interventions by the Fed, providing liquidity and alleviating stress in the dollar funding market. The resilience of emerging markets during this time was a positive lesson learned, as they have become less reliant on dollar funding and more on local currencies. However, the recent trend of foreign investors holding large amounts of emerging market debt, particularly in local currencies, may not deter them from continuing to invest, as over 80% of emerging market sovereign bond issuance is in local currency. Overall, the financial crisis of 2020 provided valuable insights into the interconnectedness of various financial markets and the importance of resilience in the face of stress.

• Investor behavior during stress periods and currency mismatches: Emerging market governments' local currency borrowing success can be impacted by investor behavior and currency mismatches, amplified by exchange rates. The Fed's intervention helped, but investors should stay cautious about future liquidity demands and investor behavior.

  While emerging market governments have been successful in borrowing in local currencies, it's essential to consider the investor behavior during periods of stress. Investors, who may be dollar or euro-based, could face a currency mismatch, leading to selling pressure. The exchange rate also plays a significant role in amplifying gains and losses for investors. The Fed's intervention in March to ease liquidity strains in the treasury market was crucial, but specific structural issues existed then. While the situation has improved, investors should remain cautious and consider the potential for future liquidity demands and investor behavior.

• Federal Reserve's intervention in the financial crisis and the role of fiscal authorities: The Federal Reserve's intervention in purchasing securities and fiscal authorities' quick response with large packages helped stabilize the economy during the financial crisis by preserving relationships and anticipating crises.

  During the recent financial crisis, the Federal Reserve intervened directly to purchase securities from dealers who were facing balance sheet issues and sale pressure from emerging market central banks. This intervention helped stabilize the treasury market, which is crucial for the overall functioning of financial markets. A surprising development during this crisis was the quick response from fiscal authorities in implementing large packages to support those in need. Central banks also played a role in keeping the payment system functioning well. The crisis taught us that the economy is not just a collection of individuals, but a complex web of interconnections between suppliers, customers, and workers. Preserving these relationships was essential to ensure a smooth restart of the economy once the crisis passed. The BIS, often referred to as the central bank's bank, highlighted the importance of anticipating and figuring things out before they happen to mitigate the impact of crises.

• Preserving social fabric and managing bankruptcies during crisis recovery: The dollar's dominance in global trade and finance is expected to continue, with central banks and fiscal authorities collaborating to manage the crisis.

  The process of rebuilding relationships and economies after the crisis will be a long and complex one. The preservation of social fabric and careful consideration of which firms should undergo bankruptcy processes are important tasks. The dollar's preeminence in global trade and finance is a coordination problem, and the actions of the Federal Reserve during the crisis have reassured the use of dollars in this respect. While there may be shifts in the centrality of currencies over the very long term, the dollar's dominance is expected to continue in the foreseeable future. The collaboration between central banks and fiscal authorities has been crucial in managing the crisis. As a leading real estate manager, Principal Asset Management provides local insights and global expertise to uncover opportunities in today's market. The speaker also touched on the topic of the dollar's role in global trade and the lack of significant changes to the dollar's long-term future story.

• US dollar's role in advanced economies' fiscal packages: Advanced economies can issue more debt due to larger budgets and funding guarantees, while emerging markets rely on conventional bond financing and are cautious about monetary financing due to currency depreciation and inflation risks.

  The role of the US dollar is expected to remain significant as advanced economies implement larger fiscal packages and consider more aggressive monetary financing, potentially leading to increased indebtedness and tighter control from governments over private economies. However, emerging markets have historically been cautious about monetary financing due to the risk of sharp currency depreciation and resulting inflation. This wariness is driven in part by the limited appetite of global investors for absorbing new debt issuance. Advanced economies, with larger budgetary measures and funding guarantees, have been more successful in implementing large fiscal packages, while emerging markets have relied more on conventional government bond financing. The challenge moving forward is the capacity of the market to absorb the expected influx of new debt issuance.

• Constraints on Fiscal Policy in Advanced vs. Emerging Economies: Advanced economies with central banks issuing reserve currencies have more fiscal space, but constraints still exist. Emerging markets face greater limitations. The effectiveness of fiscal tools depends on the economic recovery.

  While emerging markets face fiscal constraints due to limited resources, advanced economies, particularly those with central banks issuing reserve currencies, have more fiscal space. However, there are still constraints, and the use of fiscal tools depends on the economic recovery. The quick and aggressive fiscal intervention this time around may have been a one-off, but if the economy faces another wave of the pandemic or prolonged damage, further intervention may be necessary. It's crucial to learn from the experiences of emerging markets and consider the consolidated balance sheet constraint when discussing fiscal policies. The MMT discussion in the US should broaden its perspective to include the unique role of the Federal Reserve as the issuer of the reserve currency. Ultimately, the use of fiscal tools depends on the economic situation and the ability to stabilize the macroeconomy.

• Role of Fiscal Policy in Economies Amidst Coronavirus Crisis: The coronavirus crisis is revealing the importance of fiscal policy in boosting economies and reducing inequality, but the availability of resources varies greatly between developed and emerging markets, potentially leading to increased international inequality.

  The ongoing economic crisis caused by the coronavirus pandemic is raising questions about the role of fiscal policy in boosting economies and reducing inequality between developed and emerging markets. While developed nations like the US have the resources to invest in fighting the virus and supporting their citizens, many emerging markets do not. This gap in fiscal space could lead to increased international inequality. Additionally, the length of time it takes for economies to recover will be crucial in determining the future direction of fiscal policy. If unemployment trends down, we may return to the old ways. However, if economic activity remains at depression levels for an extended period, political pressure for radical policies could increase significantly. Overall, the crisis is highlighting the importance of fiscal policy and the stark differences in resources available to different countries.

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