In a Bank for International Settlements (BIS) webinar held on April 30th, Yale Program on Financial Stability (YPFS) director Andrew Metrick presented a four-phase model of central bank responses to the COVID-19 crisis. The webinar attracted over 700 participants from the international banking community.
Metrick described the first phase that has already passed as "run," followed by "rescue," "recession," and "recovery." The model is based, in part, on a YPFS tracker that has logged over 2,000 interventions by central banks and governments to aid financial systems in the wake of the economic dislocations brought about by the global pandemic. The model also derives from examination of previous financial crises.
According to Metrick, the world is entering the recession phase of the response model. A key challenge of the latest phase of the crisis is maintaining the health of the banking system so that these institutions are available to aid in the recovery phase. He noted that government interventions can harm financial institutions and lead to a "hollowed-out banking system" unable to aid in recovery efforts.
Metrick added that another key challenge of managing the coming phase was ensuring that emerging market countries received aid to maintain their economies during the recession phase. Emerging countries do not have the fiscal cushion to support their economies and must look to the developed world for direct aid.
Metrick noted that neither helping the banks in the developed world nor providing direct aid to emerging world would prove politically popular.
From Run to Rescue
According to YPFS tracker, government interventions to counter the first phase of the economic dislocation caused by the pandemic centered on stemming a run on the liquidity of financial institutions and markets. Central banks adopted emergency liquidity measures to backstop wholesale funding markets. Most of these measures were developed during Global Financial Crisis of 2008-9 and rolled out quickly.
As during the Global Financial Crisis, the US Federal Reserve system emerged as a global lender of last resort by quickly establishing emergency swap lines with other central banks throughout the world. Metrick pointed out the dollar volume of these swap lines currently has equaled the volume experienced during the Global Financial Crisis.
After this flurry of activity from mid-March to early April aimed at supporting the liquidity of markets, governments entered the rescue phase of their response. Programs enacted during the most recent phase have been directed at preserving key industries hardest-hit by the pandemic and small and medium-sized enterprises. In the United States, this includes the CARES act that has allocated monies to industries like the airline industry as well as more modestly sized enterprises.
According to the YPFS research, rescue programs have already run into numerous problems in distributing funds. A survey of rescue programs showed that some provided inadequate financial incentives to induce bank participation and therefore had to be revised. Other challenges included provisions that targeted assistance in such a way as to create administrative burdens that reduced the speed at which applicants could gain assistance or offered assistance that did not actually meet the needs of targeted recipients.
One additional rescue item could become of importance during the recession phase – the rescue of regional and municipal governments. In the U.S., the Federal Reserve created the Municipal Liquidity Facility to purchase state and municipal bonds as well as allowing municipal bonds to be used as collateral under other fed programs. In countries such as Colombia and Finland, federal governments have provided direct capital injections to local governments.
A Prolonged Recession
Metrick noted that the economy was entering the recession phase of the response to the pandemic. He argued that this phase could last for some time. Even if governments lifted restrictions on social gatherings and businesses, demand could be depressed until a vaccine or effective treatment for COVID-19 was developed.
During the recessionary period, government fiscal policies would increasingly become important in alleviating distress in the face of reduced demand. These programs could include measures to support individuals and households, such as unemployment insurance and wage subsidies, direct support to household regardless of need, income tax cuts, and tax deadline extensions. Further support for industries also could be in the cards.
In addition, Metrick observed that governments were increasingly turning to macroprudential policy easing for reducing recessionary pressures. Macroprudential policy easing is defined as "the temporary relaxation of financial requirements with clear guidance." Measures following this policy stream include releasing banks from complying with buffering requirements of various kinds, as well as changes to bankruptcy rules to favor debtors. Many of these guidelines were enacted in response to the Global Financial Crisis which was caused by problems in the financial sector in the developed world. With a healthier financial system in place and a need to increase lending, governments are easing regulations.
Metrick noted that while governments in the developed world were focusing on their own citizens, emerging market countries were beginning to feel the economic effects of the crisis. The pandemic was taxing health and economic systems in these countries. However, most of these countries had neither the fiscal resources of the developed world nor the macroprudential tools to ease economic dislocation. Over 100 countries had already applied to the International Monetary Fund for emergency financing.
The Road to Recovery
While Metrick argued that the end of the recession would be dependent on medical advances, he argued that challenges faced during the recession phase would help determine the speed of the recovery. However, this could require overcoming political obstacles.
In the developed world, banks could face challenges as their resources were stretched. While macroprudential easing was providing banks with increased capital to lend, other programs could hurt bank capital like loan forbearance and debt relief. Metrick argued that banks needed to emerge from the recession with strong capital structures in order to grow the economy during the recovery. However, helping banks was a difficult political proposition.
During the question session, Metrick argued that governments should enact bans on bank stock dividends and share buyback programs. This would help banks who might be tempted to engage in these actions to demonstrate strength to the financial markets, while at the same time easing political pressure against capital injections should that become necessary.
For a sustained global recovery, Metrick added that countries in the developed world also needed to think about how to help emerging market countries. He noted that loans would probably not be enough to help countries and that some form of direct aid would likely be necessary.