Monetary Policy in Pandemic Era: Comparison to 2008 2009 Financial Crisis and Implications

Monetary Policy in Pandemic Era: Comparison to 2008-2009 Financial Crisis and Implications Mickey D. Levy Berenberg Capital Markets Global Interdependence Center 38th Annual Monetary and Trade Conference November 19, 2020

The Pandemic Era: Expansive Monetary Ease and Broader Roles of Central Banks • The pandemic and government mandated shutdowns globally differ significantly from the Great Financial Crisis (GFC) of 2008-2009 • The pandemic is an exogenous shock that temporarily lowered economic activity whereas the GFC was a financial crisis • US Fed is far more expansive than during GFC: 0% rates and massive QE, liquidity infusions plus lending to businesses, etc.

• Direct involvement in credit and fiscal policies

• Other central banks—including the BoE, ECB and BoJ—0% or negative rates, massive QE and expanded mandates

Implications of Monetary Policies • The Fed’s ultra-easy monetary policies along with fiscal policies (the CARES Act) has helped support the solid economic recovery • Real GDP expected to recover to pre-pandemic level by year-end 2021 • There are upside risks to US inflation • Financial market implications: • Sustained zero rates for several years • Bond yields are very likely to rise • Support for stock market; very unhealthy relationship with financial markets

• CBs have expanded monetary policy beyond its natural scope, with little longer-run benefit but significant risks and unintended consequences

Pre-GFC and Pre-Pandemic Environment Pre-2008-2009 Financial Crisis

Pre-Covid-19

• Solid economic growth, debtfinanced housing bubble, inflation a concern • China and global trade booming • Fed monetary policy and interest rates normal • Focus on dual mandate • ECB, BoE normal, BoJ 0% rates

• Soft growth, low unemployment • Low inflation concerns • China and global trade weak, commodity prices falling • Fed and other CBs maintain enlarged balance sheets and tilt toward policy activism • Negative rates in Europe, Japan; negative and ultra-low bond yields

Monetary Policy Responses to GFC and Covid Financial Crisis

Pandemic and Government Shutdowns

• Fed reduces rates to 0%, QEI purchases of MBS • Lender of last resort (LOLR) facilities focus on short-run funding markets and mortgages • Fed pays IOER, imposes stress tests and regulates big banks • QE spikes monetary base, but not M2 as excess bank reserves balloon

• Massive QE ($2.5 trillion) of Treasuries and MBS, 0% rates • LOLR liquidity infusions, plus corporate bonds and Main Street lending • Monetary base surges, and so does M2 • Unprecedented fiscal deficit spending; boosts bank deposits

U.S. Monetary Base and M2 Both Surge

Surge in Bank Deposits, M2 and Personal Saving

Global Central Banks: Assets and Policy Rates

Observations and Implications • Monetary and fiscal responses to pandemic much more aggressive than during GFC in magnitude, scope and timing • Fed perceives it was too timid during GFC; fiscal policy appropriate

• Fed’s new strategic plan is decidedly asymmetric in favoring higher inflation and activist monetary policy; sustaining ultra-easy policies • Critical issue: will Fed’s ultra-easy policies actually stimulate the economy?

• Monetary + fiscal policies + pent up demand: likely stronger growth when pandemic ebbs; risks higher inflation, bond yields • Fed has expanded into credit and fiscal policies normally conducted by Congress and Treasury • Entangles itself in politics and threatens its independence

Central Banks Expand Monetary Policy Scope • Fed and other central banks expand mandates way beyond natural scope of monetary policy • Many of their objectives are driven by non-monetary factors and beyond their capabilities • ECB’s green mandate and inclusiveness reads like parody of monetary policy

• Risks and unintended side effects: exposure of CBs to politics and loss of independence; misperceptions about capabilities; imposition of low rates; accentuates income and wealth inequalities; inflation risks • Difficulties of returning to normal monetary policies