Monetary and fiscal policies as anchors of trust and stability

foreign [Music] I'm Michael Woodford the chair of Columbia's Department of Economics I'd like you I'd like to welcome all of you to our event on the theme of trust in money and government on behalf of the program for economic research in the department of economics and the Jerome a Chason Institute for Global business here at Columbia business school it seems not that long ago just around the turn of the Millennium when policy makers here in the U.S and also in a number of other countries congratulated themselves on having made macroeconomic instability a thing of the past of course declaring history to be over turned out to be premature also with regard to the problems of economic stabilization looking back we now see that what it seemed to be an unusually stable period both for real economic growth and for the control of inflation Mass growing imbalances that were largely overlooked until the global financial crisis of 2008 forced everyone to become aware of them in the aftermath of that crisis both policy makers and academic commentators now keep a much closer eye on possible threats to financial stability but it's worth asking whether there might be other kinds of growing imbalances that have also been neglected though they steadily become more dangerous the longer they're ignored and I think one candidate for such a neglected imbalance is the way in which public debts have steadily grown relative to the size of national economies over the past several decades but even more rapidly in response to the crises of the past 15 years and also the way in which central banks have become increasingly deeply involved in making a market for these large stocks of public debt to speak to us about these issues today we're very fortunate to have Dr Augustine Carstens who as you know is the general manager of the bank for international settlements the International Financial organization based in Basel with the mission of facilitating International cooperation between central banks particularly on issues relating to monetary and financial stability since receiving his PhD at the University of Chicago Dr Carstens has had an extremely distinguished career in public service in addition to his work at the bis he's been a deputy managing director of the IMF more recently he has chaired the imf's policy advisory committee in his native country of Mexico among other things he's been both Finance Minister and then later governor of the Central Bank the bank of Mexico so he's had a lot of occasion to reflect on the challenges of conducting monetary and fiscal policy and the ways in which each of these can complicate the job of the other one and from the vantage point of both sides of the street we could hardly hope for a better Guide to the challenges that policy makers around the world are likely to face in coming years so let's all welcome Dr Augustine Carstens [Applause] thank you very much Michael for this very nice introduction thank you Glenn for having inviting me here to speak to this distinguished group great to see all friends and professors like Jose sheikman that was with me at Chicago I mean he was teaching I was there just learning a models from him to Trisha it's great to see her in here in Colombia in any case it's a real pleasure and honor to speak to you today we're again living extraordinary times inflation has surged to levels on scene for Generations Financial systems have come under strain recent bank failures are the most prominent example but not the only one for the first time in decades High inflation and financial stress are emerging in tandem both have their immediate specific causes but they are symptoms of a broader and deeper problem monetary and fiscal policy have tested the boundaries of what I call the region of Civility this is the constellation of monetary and fiscal policies that over time supports macroeconomic and financial stability keeping the inevitable tensions between the two policies in check staying clearly within the boundaries of the region prevents economic damage from inflation Financial stress and slums and it allows policies enough Headroom to deal with unexpected shocks the Region's boundaries are elusive they cannot be summed up in simple metrics like a limit for public debt to GDP or the policy interest rate the region evolves over time influenced by long-run forces that shape the structure of production and finance macroeconomic policy settings can themselves alter the boundaries the recent challenge to the boundaries is the latest in a long journey at each step the policy choices seemed reasonable even compelling but they have brought us to a very complex place first Tailwinds such as globalization masked what was once a key signal that policies were testing the limits High inflation then Financial liberalization gave rise to a new warning sign Financial instability punishing inflation made many think that monitoring fiscal policy could resolve every economic problem policy makers deployed stimulus in recessions but did not rebuild policy buffers when growth resume the pattern became Starker after the GFC when extreme uncertainty prevailed economic activity collapse and inflation hovered stubbornly below Target even the circumstances it seemed natural that authorities could use their policies to promote growth without stalking inflation so their ability to do so relied on aggregate supply adapting smoothly to changes in aggregate demand this was the case for some time but when the pandemic made Supply conditions unusually inflexible we saw the magnitude of the risks that were taken a shift in mansite is called for retreating from the boundaries of the region of stability and remaining clearly within in within in should be a conscious and explicit policy consideration let me elaborate first on the role of physical and monetary policies and causing and addressing the immediate challenges of inflation and financial instability and second of the forces that led policy makers to approach the boundaries of the region of stability I will conclude with some Reflections on how to return to a more comfortable location within the region the first major challenge policy makers face is inflation it has been two years since inflation returned with the bengans it has become widely entrenched across countries and sectors the courses have been well documented including disrupted Supply chains a rebound in demand and the war in Ukraine these forces were powerful but the policy stimulus deployed during the pandemic gave inflation an even larger unexpected push interest rates were lower lower to zero or below central bank balance sheets balloons fiscal stimulus exceeded 10 percent of GDP in many advanced economies in many countries households received large transfers firms benefited from subsidies to keep workers on the payroll these measures added to demand when Supply was constrained boosting inflation or doing little for growth the stimulus continued and even grow grew long after economy after economies started to recover the policy responses to the pandemic were Justified at the time they kept firms afloat and preserved livelihoods and they prevented economies from falling into a tailspin but calibrating stimulus was extremely difficult in this environment in hindsight policy support was too large too broad and too long lasting at first most observers including central banks expected higher inflation to be transitory and some of it was oil used cars and shipping are cheaper now than a year ago in much of the world inflation has stepped down from last year's Peaks but the next phase of today's inflationary journey is tougher the AC gains have largely been banked Services were price prices are stickier have become the main driver labor markets are still tight growth may need to slow more for monetary policy to gain traction there is no time to lose the longer inflation lasts the more likely a shift to a high inflation regime households and firms start paying much more attention to inflation and expectations become the anchor the genie gets out of the bottle the costs of retaining price stability growth public support waivers for traveling The Last Mile required to return inflation to Target interest rates may need to stay higher and for longer than previously thought if they do governments will feel the pinch in much of the world public that Rose steadily as a share of GDP positive GFC the covetera stimulus has raised Dead Further and servicing costs are rising fast meanwhile slower growth will stay in strain public finances quicker fiscal positions could complicate Central bank's efforts to lower inflation in the near term Fiscal stimulus Rises inflation partly on doing the effects of tighter monetary policy even if higher inflation has helped lower public debt to GDP ratios this does not provide exploitable physical space indeedtimf expects public debt levels to increase again and because persistent inflation calls for higher interest rates it makes high public debt less sustainable over the longer term central banks may come under pressure to slow the pace of tightening to ease the burden of public finances even where higher interest rates are manageable central banks May face calls to take the foot of the break or raise the inflation Target larger Central Bank losses resulting in smaller transfers to the government are adding to the pressures the second major challenge policy makers face is financial instability our outsized fast-paced and Ultra sophisticated Financial system is Fragile with excess leverage and liquidity mismatches financial institutions and markets including Banks and non-bank financial intermediaries stretch each other to the Limit with uncanny regularity as the edge approaches unconfidence suddenly evaporates fourth lines emerge wherever the boundaries of stability May lie this type of financial system blurs their Contours over the past year we have once again seen signs of stress this is no surprise banking stress breaks out frequently in the wake of monetary tightening larger increase in inflation and higher levels of private sector debt makes stress more likely now for the first time since the second world war very high private that coincides with research in inflation and all this has transpired after an unusually long phase of aggressive risk taking in financial markets in some recent episodes of financial stress it is hard to miss the footprint of the cumulative impact of monetary and fiscal policies for over a decade many sovereigns issued large amounts of dead at very low interest rates and long duration the bulk was absorbed by Banks investment funds insurance companies Pension funds and hedge funds which became exposed to the risk of higher interest rates expectations of continued low rates shaped business models Fuel risk-taking and encouraged Leverage this promoted aggressive maturity transformation and liquidity mismatches and Amplified the potential for financial stress consider two recent examples Silicon Valley Bank went under because it's largely uninsured and concentrated depositor base woke up to high unrealized losses on long duration securities a classic depositor run and liquidity squeeze Force recognition of these losses this triggered broader contagion across medium-sized U.S Regional Banks problems in UK Define benefit Pension funds thus here originated from Hedges against further declines in interest rates implemented through leveraged funds as monetary policy was tightening an unexpected fiscal announcement profit yields up the Hedge is generated losses that threatened the solvency of the investment vehicles prompted a liquid squeeze this triggered forced sailing of government paper in a falling Market the hedgeus protected the solvency of the Pension funds on not that of the vehicles in which they had invested while in the UK episode concerns about the fiscal position caused localized stress the damage can be much larger doubts about Sovereign credit worthiness can destabilize the whole financial system a Sovereign Bank Doom Loop is triggered when Banks exposures to the same Sovereign put institutions by ability in doubt such episodes are more common in Emerging Markets what advanced economies have not been entirely spared financial crisis can also wreck havoc on fiscal accounts and endanger fiscal sustainability Costa's economy tanks sapping tax revenue The Sovereign has to step in as Pakistan central banks can provide liquidity but only governments can address solvency the fiscal costs can be very large the risk of financial instability heightens the challenges that central banks face as they seek to restore price stability the risk would be larger should central banks have to keep interest rates higher for longer substantial additional tightening could prompt renewed Financial turmoil and financial turmoil may require the central banks to intervene to stabilize the financial system as lenders of Mark lenders or market makers of Last Resort let's look in more detail at the past to weather understand how we got here the journey to the boundaries of the region of stability was not linear the symptoms of an overly expensive policy stance evolved with the economic landscape together with more fundamental structural forces a consistent Factor was overestimating of how far macroeconomic policies could be used to steer the economy and ignite the engine of long economic growth we can think of two phases going back to the 60s in the first phase from the late 1960s to the mid-80s surgeon inflation was the red flag signaling that policies had overstepped the boundaries of the region of stability recessions were typically triggered when monetary policy was tied into time inflation policy makers believed they could fine-tune the economy by carefully calibrating the mix of monetary and fiscal policy the result was the great inflation of the 1970s in response policy makers try to bring policies back within the region of stability central banks aggressively hiked rates this exposed fiscal fragilities with persistent deficits public debt surged many governments were forced into fiscal consolidation public debt levels on average stabilized in the second phase from the late 80s to the eve of the pandemic changing macroeconomic policy Frameworks when hunting hand with fundamental structural change Financial systems were liberalized by the early 90s a government LED Financial system had given way to a market-led one the globalization of the real economy followed against the inspectrop the nature of the business cycle changed inflation ceased to be the main symptom that policies were testing the limits the symptoms now took the form of financial imbalances inflation induced recessions gave way to Financial recessions Financial Cycles became larger and more disruptive culminating in the GFC the shift from inflationary to financial imbalances gradually eroded policy space monetary policy East during contractions to caution the economy and offset private sector balance sheet repair but it had little reason to tighten during expansions even low unstable inflation interest rates progressively declined for fiscal policy the GFC was a watershed financial crisis forced sovereigns to backstop the financial system and support faltering economies public debt increased massively sustained by low rates the challenges intensified after the EFC monetary policy struggled to push inflation back up to Target as fiscal policies sought to regain lost room for maneuver monetary policy became the only game in town As Time war on fiscal policy was then asked to give a helping hand and then the pandemic and the Russian invasion of Ukraine struck what does this mean for policy let me sketch a broad direction of trouble the immediate priority is to restore price stability central banks will also need to address any further Financial strains that might emerge if a high inflation regime set scene the costs to price and financial stability will be too high at the same time we must differentiate measures designed to lower inflation from those safeguarding financial stability immediate need of the financial sector must not compromise the tightening needed to lower inflation fiscal policy also has to play its part consolidation would help to reduce pressure on aggregate demand and inflation limit the risk of being a source of financial instability and provide more Headroom in case of solvency concerns as monetary and fiscal policy acting in tandem bring inflation under control Financial instability should subside the longer term challenge is to ensure that monetary and fiscal policies operate clearly within the region of stability on a lasting basis this has to do with strategies institutions and mindsets policy strategies should aim to keep room for maneuver over time this calls for a more symmetrical policies over the business cycle arguably there is room for monetary policy to tolerate tolerate moderate shortfalls of inflation from point target once inflation settles at very low level in a low inflation regime inflation has certain self-stabilizing properties as a result the central bank can better enjoy the fruits of its hard-earned credibility this helps to make the interest rate cycle more symmetrical and reduces the need to keep rates on usually low for unusually long thereby limiting the buildup of financial vulnerabilities when assessing fiscal space policy makers must account for the flattering effect of financial bombs on the fiscal accounts and the possible costs of financial stress with respect to fine to to Financial to the financial system South micro and macro presidential Frameworks must complement monetary and fiscal policy this is particularly relevant to allow monetary policy to fully concentrate on the abatement of inflation a lot has been done to strengthen the financial system there has been good progress in the banking sector although recent strains suggest there is still work to do what reforms have lacked in non-bank financial intermediation which have grown markedly institutional safeguards can limit tensions between the two policies and promote their coherence Central Bank Independence remains key mechanisms to encourage prudent fiscal policy should have greater bite ultimately though what matters most is mindsets policy makers must acknowledge the limitations of macroeconomic stabilization policies they can be a major Force for good but also cause but also cause great damage the journey I have described shows that if the specific challenges evolve with the economic landscape the root cause of failures does not to generate resilient and sustainable growth there is no alternative to working on the supply side of the economy structural reforms are politically difficult but there is no free launch the region of stability concept heart as it may be to apply in real time embodies a recognition of the limitations of macroeconomic policies the region is not a number or even a set of numbers but a way of looking at the world and guiding policy it can help preserve the all-important trust that Society must have in the state and its decision making thank you very much just to give you all a sense of a run for the rest of the discussion I'm Juan Albert from the business school and the econ Department you've met Mike Woodford Mike is the economics department chairman but that's just a rotating punishment handed out over years he's actually one of the world's greatest monetary economists uh Trish Mosser is a former Central banker and head of the program for economic policy management in the School of International and public affairs we're each going to give a short perspective on Augustine's remarks on the region of stability uh ask him for a little response maybe a few questions and then we'll turn it over to you so be thinking of that Trish I'm going to ask you to lead off um so hello everyone nice to see everybody this afternoon lovely to see Augustine again uh thank you very much that was an outstanding and scary summary frankly of the macro policy challenges the world's facing right now I think I have a couple comments and I'm going to intersperse a couple questions as I go along um uh my first comment is is about the monetary fiscal policy mix wow that's like an old-fashioned term um both a terminology and a topic that seems to have fallen out of fashion in the last decade and a half but obviously should not have as your talk rightly points out um but but I I don't disagree with your your boundaries argument I think that's I think that's a very sensible way to think about it but I I do want to play a little bit of Devil's Advocate um uh on on what's happened in the last uh 15 years or so your assessment of the policy mistakes during major in the pandemic is absolutely spot on but down isn't as a first order matter the biggest problem the first problem was one of policy calibration and and by let me be specific about what I mean that basically the modelers and the policy makers just grossly underestimated um the combined power of extremely easy money and extremely easy fiscal policy looking at normal times is not a guide to that there's a certain amount over the years there's been some evidence particularly after the global financial crisis that old-fashioned Keynesian multipliers um get multiplicative when both monetary policies easy and fiscal policy is easy and they're much much more powerful another example of how non-linear the world is um the economic World anyway and so after the global financial crisis I believe many policy makers walked away thinking they hadn't done enough that's why central banks on the fiscal side or maybe they didn't go on long enough certainly that was the view in the United States um and the lesson from that is don't make the central banks be the only game in town because you can't get inflation up and you can't get in the economies to grow enough and so they co-corrected this mistake and really over corrected it in coveted by going massively overboard on the fiscal side monetary policy side too but that was exactly when Supply was constrained and the financial distress never showed up that seems like a at least partly a calibration exercise so my question to you is that it's a counterfactual actually um if the fiscal monetary mix had been better after the GFC and we could have gotten right back to regular inflation we could have gone back to growth and interest rates could have normalized do you think our financial distress concerns would be less today and you um I won't predict whether we would what would have happened during covid or frankly do you think the fiscal part of this is kind of irrelevant and then your talk suggests that monetary policy makers basically probably should have normalized rates pre-covered um more quickly than they did so that's that's so that's my first question um you want to go on okay um second comment uh is about the nature of fiscal policy um monetary policy is one size fits all it's a very gross tool fiscal policy is exactly the opposite right it's it's a it's a diverse set of tools um capable of helicopter money pure demand stimulation a lot kova just write everybody a check and encourage them to go out and spend it or alternatively being very very potentially being very very targeted for example for to structural changes in Supply um given that so many countries are going to have limited fiscal space in the coming years I'd be interested in your views an interest in Glenn's views too um on what part of fiscal policy recalibration might be most helpful um in the years ahead so that's my second question last but not least um I just have to say something about financial stability because I spent the big chunk of my career working on it for at least a dozen years everybody and his mother in the financial stability World which I used to be one of those people has been saying that the buildup of Leverage of duration risk of ill liquid non-linear credit instruments but daily liquidity redemptions and opacity particularly in the non-bank sector was a prescription for financial instability in the future it's a bit like crying wolf uh didn't do much good uh now in some cases countries did deploy macro Prudential tools but of course they removed most of them during covet so um uh and and in addition most macro Prudential tools are very very focused on the largest global Banks the sad truth is that most of the risks I just listed were major contributors to the Panic during the global financial crisis but with the exception of addressing regulation around the largest global Banks almost nothing has been done to address them frankly regulatory systems and the financial safety nets are shockingly inconsistent with the actual structure of the financial system globally and the systemic risk that it poses to economies um and unfortunately I'm afraid that if history is a guide that it's going to take another crisis unfortunately to actually fix things okay Mike so I'd also like to really thank Dr Carstens for that wake-up call I think we have a lot of reasons to be concerned with recent Trends in policy and with um the lack of a clearer sense of what the rules are for when we're going to use uh particular policies with regard to the question of you know the interpretation of um the idea of a region of stability that we should be concerned about straying out of I mean I think there is a question of whether one should really think that that simply means we should never be willing to deviate from typical approaches to policy it's not clear to me that the mere fact that the policies for example in response to covid were quite unprecedented means in itself that they were that they were inappropriate um to the moment or at least that doing something quite different from business as usual wasn't appropriate to the moment uh in particular I think your remarks emphasize the idea there was an excessive fiscal response and that that perhaps this didn't do that much uh for economic growth although it boosted inflation and I think it's clear that the policies the fiscal responses that we had weren't very well targeted uh and and they probably did go on then farther than it was necessary to do but I actually think there's more reason to criticize the monetary policy response than the fiscal response as something that was unwarranted and in fact excessively and inflationary and the reason relates to the type of shock that had just hit the economy which it seems to me was one that if any kind of economic shock justifies the use of fiscal transfers as a response this was almost the textbook textbook case of it because what happened suddenly cut off normal sources of income to many people in the economy but concentrated in very particular parts of the economy not to not not at all to people equally uh and it was not the kind of shock that um that monetary policy was at all well suited to deal with so it's true that um you know economic activity was uh abruptly and rapidly slashed but not for reasons that say cutting interest rates or even buying a lot of longer term bonds adding them to the central bank's balance sheet would do that much about monetary policy can stimulate spending but in this particular kind of case the people for whom it could stimulate spending which would be the people who are not the credit constrained uh were not the people who to have a more efficient allocation of resources one needed to make it possible for them to spend more and instead fiscal policy was very well suited to do that even if it was aroundly untargeted fiscal policy at least they got checks to the people who were badly in need of some way of of continuing to be able to spend and of course it's possible for fiscal policy to even be more precisely targeted and that's also an advantage in dealing with that kind of a shock so it's um it on the other hand seems to me that the monetary policy response was was not at all justified by what had happened it was not a type of shock that should have made one think that interest rates needed uh to be lower um in the economy at that point in time and um in particular it was I think a mistake not to realize that the strong fiscal response that had happened which was very different from from previous crises was one that should have meant there was much less need to respond with the monetary policy Playbook that was used and I think that was pushed much too far and continued continued for much too long now with regard to the longer run issues being addressed in the talk I think I have a lot more sympathy with the view that fiscal policy is something uh to be to be very worried about I think that if we're asking what's concerning about longer run Trends in stabilization policy there's a lot of reason to worry about what seems to be the long run trend of fiscal policy which is moved toward larger and larger expansions of government debt and never the retrenchment only moving further and further into new territory and more reason to worry about that actually than the trend I think of monetary policy over um over recent decades but um also here I think that the idea of saying well what we need to just tell people is never to cross certain lines that take you outside um the region of stability is not necessarily what I would say I wouldn't say that we need to avoid ever using these unusual tools avoid ever using fiscal stimulus avoid ever using lower for longer monetary policy commitments or ever using central bank balance sheet policy instead it seems that it's important to limit the use of these special tools to times when they're gen genuinely needed and so I think that what people need to think more about is the need to undo these policies and offset them at other times exactly in order to create more policy Headroom to use those special tools at the times when they're especially valuable well thank you Augustine especially for for being here just offer a few remarks for myself and then obviously love to hear your thoughts on anything we've all said I thought your image of a region of stability is a very good one because it emphasizes a region and not a point there are for many of the reasons Mike said this is going to be a complicated Journey as I listen to you I I fought about the root word from Latin for credit Credo I believe this is essentially a story whether it's about financial markets or about public policy uh about trust and I think of that in in two elements and you mentioned both but one a little more than the other in your remarks one is about financial markets and monetary policy but also something I want to come back to about political economy of some of the policy errors uh that you that you mentioned to policy you know if we take us ourselves back to 2008 remember the fiscal policy debate of targeted timely and temporary that's beautiful alliteration is also wrong as a as a as a policy response monetary policy was also very halting we For Better or For Worse unlearn those lessons uh going into to covid and now we're confronted more with metaphors from policy makers of driving in a fog and if you drive in the fog driving either too fast or too slow can cause an accident like Mike I I think that that's uh more of a problem for fiscal policy I think monetary policy is the one where the bigger errors uh were made I think it was pretty clear that monetary policy was not doing what it should have done during the the covid period uh going further back we could ask how wise it was that policy was so easy for so long and what were the build up that we could have expected for a bank and non-bank financial institutions building on something Trish said I've worried for some time about the marriage of three factors the desire to provide great liquidity for the public to do so in relatively opaque instruments that are also subject to a great deal of interest rate risk that is not a healthy cocktail for either bank or non-bank uh financial institutions you know returning to the issue of trust uh it strikes me that there's several layers here one begins with the central bank the Federal Reserve here central banks uh in in most industrial democracies have a lot of work to do to rebuild their credibility with the public uh starting with their commitment uh to inflation they also have a great deal of work to rebuild their credibility in explaining what they do as Mike was reminding us the difference between responding to demand shocks and Supply shocks uh for a for a central bank central banks in this country and in most countries are also very heavily involved in financial regulation and here there's an ultimate need to build up uh credibility again in thinking about supervision uh and Banking and what we want financial institutions to do but the biggest thing on my mind in listening to the remarks this afternoon is rebuilding trust in the presence of of two things both of which have already come up in this conversation one is about unsustainable fiscal policy that is truly the low frequency gigantic problem uh of our time in terms of an ongoing uh policy error in terms of the link to Central Banking and to banking itself there are real constraints on central banks in an era when the public sector uh simply isn't apparently cognizant of the inter-temporal budget constraint in terms of what to do about it um I liked very much and Augustine's remarks mention of things like independent fiscal councils we've learned from some countries Sweden comes immediately to mine of the success of such organizations but it will be a huge challenge for central banks and policy makers the second area of trust that didn't get as much discussion here but I think in terms of the politics of this is even more important is a political economy concern the policies that were pursued uh in the great financial crisis and again during covid I did two things one they exacerbated income and wealth distribution problems not as a deliberate goal of the policy but as a corollary of a policy to keep rates very low thereby inflating the value of assets good for owners of assets and a perceived failure in much of the public that certain institutions or types of businesses might be bailed out banks in the case of a global financial crisis uh once again in the present period as opposed to other situations in the economy homeowners in 2008 small business people today I say that not the question the wisdom of the particular policy moves but the absence of political economy concerns so just to wrap up where I began I I do think Augustine has done us a huge favor both by defy finding this region of stability and pointing us back in this director direction of trust why don't we let you chat with us about any of that we'll talk among ourselves but wildly and then turn to all of you well thank you very much I hope they give me a degree after I answer all these questions [Laughter] no excellent excellent questions say and I I think this will allow me to clarify some views and well obviously to express in general I would say high high level of a coincidence with many of what you have said it's probably more an issue of nuances let me start with three Trisha um though your first question you mentioned a lot of political calibration I definitely think that's the key issue I I said it in the speech I think I mean I think also and this has to do with a response to other of the comments that have been made a and it's something that we need to see how see how certain is what I have to say both you know we came from over a decade where monetary policy was very aggressive and nothing happened to inflation it then came the pandemic in particular and we have to remember that the pandemic was considered considered first a major deflationary shock I mean the expectation was that the economies were going to tank as a matter of fact they tanked that you know the floor was pulled out of everybody I mean I think it's the first experiment where we try to eradicate the pandemic by bringing work the world economy pretty much into animated suspension nobody works nobody goes to the offices you know you just need to survive a so I mean what was the expectation about growth a one reason for monetary policy to act be within limit is there was huge concern huge concern about the survivability of many many firms especially when you mentioned the distributional aspects I mean which are the weakest links a small medium-sized Enterprises family houses and things like that as a matter of fact if you remember a lot of the programs that were implemented were geared towards those firms now if that wouldn't have made wouldn't have a push forward I think that the consequences would have been extremely extremely grave I think that the real surprise was thus was that the rebound was very very fast part of it because of of the vaccination which obviously was welcome but also about the fiscal response a now you can say that the FED acted a little bit late or quite late or I mean I don't know want to use it in objective but it was a matter of weeks or months more than weeks a and and actually it really became very seriously once the Ukrainian work came in a major debate among among central banks is the issue a how much is temporary how much is permanent and and you know the dogma of well the the doctrine of Central Banking is that if you have a relative price change you should not try to bring down inflation in all the other goods and services in the economy to hit the the right aggregate I think that was that affected a lot of the policy making of the policy making uh at that time uh also in in here in here I have to say the political economy was also a very important factor central banks just didn't want to abort the nation's recovery and and you know we're coming out of a huge shock where you know nobody was working nobody was going to University nobody was traveling Services were collapsing and then suddenly you go you come with a very strong response from the central bank that's very difficult to engineer so I think calibration just was an issue and it was not only in in the end and I think what was the most important shot is how we went from a situation where aggregate demand stimuli could be met seamlessly by the aggregate supply for me this is the key issue and suddenly came the pandemic where where Supply got completely distorted and this one then additionally distorted by a by the war to to train so suddenly you you come from a period of the at least 15 years or even more with globalization with value change uh all all of those things where you could push and push and push and push and aggregate supply was there all the time to the point that it was very very difficult to increase inflation so in a way I think that what was very difficult for Central advance to do was to precisely to calibrate the response in the face of those responses I can tell you that if we had a a crystal ball and we could have anticipated the the this this more sticky response of of Supply to aggregate demand it would have been far more careful one of the things that we within quite anticipate was the shift in the pattern of the of the demand for goods you know it went from from from services to goods and then back again that they started hugely prices relative prices um so I would say that the monetary poor policy response in the face of the pandemic was was due to two factors three factors I would say one the fact that we didn't anticipate this stickiness in aggregate supply second the fact that a there was a lot of fear about the impact on the productive productive sector every product a part of the productive fabric that would have been washed out in the face of without the interest rate interest rate interest rate support and there was also some concerns about financial stability if if Android was a mixture of Market functioning plus monetary policy because if you remember in 20 in March 20 there was huge volatility and there were huge concerns about a about a a about a financial institution so it was a moment where you were I think central banks this is my own saying I I I didn't hear anything Central Bank saying this but I think if you had to air it was probably to her in that direction because given the history that we had before the threat of inflation were exposed yes but at that moment it was not considered to be that that large um policy calibration is very very important a yes fiscal policy need to be more targeted in yes it's a classic classic case what we experienced then but probably was a little bit excessive in particular in the U.S no and and the issue is that in the minds of people I still we still don't see much of a concern about fiscal policy going forward and impact on inflation and I can say that is quite important and it's something that we cannot we cannot forget about it but then and and you know this is a matter of also of of my explanation of why we were going some so many years back and I think that that in particular how to address aggregate supply and how and to have a discussion serious discussion about growth is quite absent and and I think that is probably the key one of the key aspects I wanted to highlight here we have got accustomed of using too much and too quick fiscal and monetary policy to study license I I agree with with Michael that that you know in in the face of some shocks in the face of some shocks you really have to use this type of instruments what do we need to do a permanent policy describe carried over decades and decades and decades tracking so much economic activity and and and not not worrying too much about the consequences of what I can do this that can Hound me many years into the future ensuring we start thinking more about really how can we engineer higher growth the discussion about growth today is mostly a discussion about fiscal and monetary policy and I think there as a profession and as policy makers we have four far far more to do um now Financial stability yes a it was it with the benefit of X of insight is difficult to think that law Furlong was going to last forever and therefore I think we need to mind this I think I think that I mean as you know very well the work of the financial stability board the word of the vassal committee is very slow moving although the issues are on the agenda and I really I really think that we need to move faster as a matter of fact I would say that if you are not analyze the events surrounding a Silicon Valley Bank if if you analyze the problem with Credit Suisse I think all those events a had been contemplated in basil in the discussions of puzzle and a and and well one of the problems that we have with the key regulation at least at the international level is that they it establishes floors but then they they don't the the the countries themselves can have the flexibility of a of building on that in some countries it others continue countries didn't no so I think I mean for example something that is quite discussed today is we need to put a A or or we need to address the the interest rate risk in in the banking book Australia for example have deal with it for quite some time and they have done it quite well you know so I think I I think it's a it's an issue of the discussion is out there then how how quickly is that a mapped or mirrored into actual regulation and and supervision and I think that's a that's a big challenge that we have that we have in in front of us a I think of what you said Glenn about trust I I agree with many of what you said hey but you know going back to one criticism or or comment that I think it's very important it's about the impact of all these policies of of think income and wealth distribution again here the instrument is not necessarily fiscal and monetary policy especially especially when you have to use them really to stabilize a major problems that you have have in front of you a yes I think it should be a consideration but should not be a major a major impediment I think as I mentioned to to you I think that quite some some of the measures of monetary policy did in terms of programs in terms of guarantees and so on and so forth was also to protect some of those people I definitely think that that the role of fiscal and monetary policy has to be better defined I think one of the good things about the autonomous loss of the central banks is that is a very important discussion of the reach of monetary policy and that is manifested in the law sometimes it's very clear sometimes it's not as clear as you would wish but is an advantage and I think to have that type of discussion in fiscal policy would be very important at the end of the day you need some social consensus about what these policies can do and should do and that's a way forward in having that discussion at at the the national level but for me and and here this allows me just to close to put the the the Nuance I want is not so much that we should forsake these instruments but this at the same time we should not get used to them as our instruments of of of of of First Resort and and also I don't think we can really expect to engineer high and sustainable growth with much better income distribution just by using a fiscal and monetary policy and my sense is that debate about how to get growth going is not out there it takes a long time it doesn't have it it doesn't lend itself for sure Authority showing concrete action that you can see show with the physical a yearly budget or with monetary policy but but so I mean at the end of the day if you ask me what is what we should do even that fiscal and monetary policies are are have depleted or they're close to deplete their the the the power to continue pushing for growth we need to find how can we give more breathing space to the economies and how can we engineer sustainable growth with stability as we move forward and there I mean certainly monitoring and fiscal policies should continue to as as much as they come within limits for monetary policy certainly has to be devoted to avoid inflation because inflation will not help us at all in any way a we need to enhance Financial regulation and supervision because that certainly the separation principle is important and we have to make it clearer and and more more resilient and we need more growth and if we have more growth there will be more degrees of freedom at the physical at the fiscal level and that also especially if you know for fiscal policy for example can be used to to tackle the issues of the of the bottlenecks of the economies are facing if we spend more in infrastructure a more in productivity enhancing activities and not so much in transfers I think we probably would be doing a much better job so we will have more growth just on sustainable basis that will give more breathing room to fiscal and monetary policy and with much better regulation and supervision we would also give more breathing room to monetary policy to be more effective to avoid inflation so there is for our our thoughts is going no that's great be I do want to make sure we have time for the audience but I did want to ask you a follow-up on what you just said Augustine how do you as uh a prominent International official how do you advise Central Bankers to talk in a world to prepare policy makers for a little bit less hyperactivity more of a concern about structural reforms especially in a world where of course central banks have to realize you know commenting on fiscal policy a source of many of the concerns uh might be a bit beyond their kin how do you finesse that conversation I definitely think that there is no one-size-fits-old I can tell you when I was I had the privilege of being governor and Minister of Finance a so I have seen the game from both sides and in Mexico the central bank has some space to say fiscally we need this and this and this and that because if we don't consider the interaction they are the the actions of monetary policy will have to be adjusted there are other countries in Europe for example where this can can happen there are other countries like here in the U.S where the line is is more clearly caught but I think at some point if it's not done at the public level at least at the academic level should be done you know I mean you have to respect the practices and the and the limits uh but I think that the that the that in that that it's something where where you know is very difficult to clearly quote the effectiveness or the description of the effectiveness and the actions of one policy without addressing the other monetary policy should be in normal times should be sort of predictable a fiscal policy can have more changes but especially as As you move inter temporarily and you get closer to the limits of the boundaries or to the boundaries of the region I think more more more public debate about this is important so uh let me I've got plenty of questions for the panel but let me take a break and turn the audience for questions let me just quickly repeat so people who are listening uh YouTube later will be able to hear everything the questions about structural challenges about uh why stagflation could be so bad the answer I lived through it it is we can talk offline if you like and then AI so uh over to you well I'm glad that you wrote roles that that those issues I think that's very important part of the debate we will have to have I mean huge technological development we know that technical progress since very important determinant of of growth it could have a major important I mean a major impact on labor force participation of income distribution a it it could have it could affect the productivity that's key discussion to have and to large extent that isn't independent about what happens between a fiscal and monetary policy you know if all those developments are very positive and uh and you you know we have higher productivity growth uh we will have higher real wages and probably the the pressure on uh certainly that will shift aggregate supply and that should help reduce prices in the economy so I think for me that's that's that's the type of discussion a a we should be having no not concentrate only on fiscal and fiscal and monetary monetary policy issues questions about financial stability if one took Mark to Market logic to private Equity to real estate are there issues to other shoes to drop yes foreign if Mark to Market treasury is in a very badly managed concentrated weird Bank could bring down the bank uh not marking to Market it marking to Market's the wrong way to talk about it illiquid assets what you need to do is recognize your losses right banks have to do this they're required what goes on in the less regulated part of the credit world is sometimes is who knows and of course the first inclination when you're facing losses like this is that everybody wants to say well but it's going to come back you know it's not really that bad the problem is that we probably engine the central banks because inflation is the worst is the even worse outcome have you know need to slow down the global economy a lot and in the advanced economies they really need to slow down the economies you slow down the economies and nearly always it's going to be the riskiest credits and real estate that are nearly always going to suffer and so the question is how soon do those losses get recognized um and um so I won't say a lot of marking your liquid things to Mark at least a huge amount of sometimes excess volatility frankly but recognizing the losses that are likely coming in low quality credit and in certain areas of real estate not just in the United States but in a number of places around the world is probably going to be a very big deal in the coming um my guess is in the coming year or so that type of event is the type that probably was more anticipated more reflected in the reforms are worked on post GFC I mean with the distinct distinction that in the U.S and non-bank Financial in termination is very very large very sophisticated and that that doesn't necessarily happened is not reflected in in the rest of the world I think that that many of the of the official supervision and regulation has concentrated on this on these sectors and I think for the banking system seem that this should not be a major issue now for for non-bank financial intermediation where there is a lot of opaqueness and so on and so forth yes I mean there might be some risks and and and that's one of the reasons why I fully share the view that we need to uh to dwell far deeper into those forms of financial intermediation if I could just add one thing one area uh which I think we may want to worry a little bit more is uh on certain types of open-end funds open in mutual funds that are providing instant liquidity against very illiquid Assets in times in which there's not much fluctuation that might be fine but of course that's the same logic that might be fine argument is the same argument about uh that Mr Becker made with Silicon Valley Bank well as long as people don't take all their money out we'll be fine that's that's not true so I do think they're Pockets where we want to look for as a singer marriage uh among liquidity and opacity and rate risk anytime you see that that's at least an area to consider other questions yes ma'am questions about the Federal Reserve and the financial stability oversight Council any broader Lessons Learned for policy makers well um I mean definitely there were some very specific uh U.S Centric events that they definitely are important to to reflect on and I think that's what the fifth is doing now and I think that will be very very important I mean I think I think among others the the interest rate the the the the the interest rate how to deal interest rate with interest rate risk in the banking book a issues of a key aspect and and you know these affects this also applies to other countries uh probably it hasn't been manifested with the same intensity what I think is relevant for all all the global banking system uh the issue for example of a how sticky deposits are that's a that's a key aspect that will need to be considered how to deal with a you know a a a liquidity coverage ratio in the face of considering some assets held to maturity are the Euro should not be part of the the LCR a issues that now also will have to be discussed is the discussion between Deposit Insurance and the how strong do you need to have regulation but also the issue of resolution all these discussions are important thoughts that every banking system should have today and you know we also had this major issue of credit trees which was a a very important Global a fine systemic financial institution and the that also need to be reflected in in the debate and in particular the issue of of of of resolution I think that the yes this is I mean in a way in a way it's important to have these moments in time where we can seriously rethink on where we are and what else need to be made what else needs to be done to have a far more resilient Financial system s yes issues with opaque uh credit agreements between China and other governments hey I don't understand quite well the question but um I don't think that's a major issue right now I mean there are many issues with respect to how Chinese participating some debt relief operations and I I don't think that this is reflected there just the Chinese government has granted the pvoc has granted a lot of swap agreements continue inside the agreements to Some central banks but that's not an issue that will will make more vulnerable the financial system in some cases it might even help a yeah it's it's an issue that I I don't think it it has particular relevance for the discussion and we're having today or the key discussion we're having today let me do a quick uh lightning realm with everybody as as we wrap up one issue that's come first in your excellent speech and then in the discussion surrounds a role that fiscal policy kind of plays in the middle uh either as a contributor of stability or policy errors potential intersections with a central bank policy can we get to a fiscal uh consolidation without pain and a crisis in the United States and other industrial democracies I know we can as a matter of Economics but I'm asking you can we as a measure a matter of political economy and if if so please tell us how Mike start with you [Laughter] well I I'm not going to offer you the the easy political solution I I think you're right that there's a variety of choices and so it's not it's not that there's even you know one single thing is the only economically possible solution you know it's the political process and not technocrats I think who decide you know what the desirable level of government is and therefore how much funds have to be raised to pay for it but I think the thing that economists can remind people is that particularly over time not necessarily on a year by year basis but over time there has to be a plan for how you pay for things and enacting programs and simply not asking how are they how are they being paid for isn't something okay Trish so um I'll stick to the United States here um the United States will probably at least for a little while longer because of exorbitant privilege um get away with not being as fiscally responsible as it should be um but there is a limit to that and the problem is that limit may be pretty ugly so I share your political concern that when it hits it it will not um it's going to be ugly for the dollar it's going to be ugly for U.S economy um and I am a little concerned that given the political dysfunction these days in the United States that it's going to take that sort of a really bad event to sort of wake people up in Washington not to be too pessimistic I think it's very important to have at the national level continuous debates about the long-term sustainability of the public finances the risk of not having that are extremely high because when you realize that you are far behind the curve things can unwind extremely fast a I think also from a political economy point of view a you cannot do many of these huge structural reforms from from a Public Finance point of view all at once I mean for example if you have a very low a income tax income and then you have a huge imbalance in infrastructure and then you have also a a very large Actuarial deficit in the in the in the in the in the social security system uh I think it's completely responsible to wait until the thing explode to start attacking the issue so I think there should be a debate and every every Secretary of the Treasury or every Minister of Finance as it was my two I for example the increase for the first time in many years the value of the attacks probably one of the reasons I ended up in the Banco in Mexico it was because of that so I basically passed to a better life because it's much nicer to win the in the central one but you know there should be an action a major action almost in every single Administration otherwise it will not happen now politics yes it's tremendously difficult but that's why you have to have the debate there is something that needs to be pushing the political political forces to the point where you have to mind these long-term equilibrium because if not it's very difficult to make also each Administration has to do something in that line otherwise this does not converge just give you a chance for any last word you want to give us on your remarks on the region of stability well let's help us develop the idea I mean this is a this for us to have this I mean here you have very important thought leaders we have learned a lot from from you we need to have a this type of discussions where we try to bring everything together and try to have a weather gouge of where the economy where the economy is going it were and were the key stress points are because also there are stress points that that if something breaks on the fiscal side it probably will affect monetary and if something is breaks in the monetary will affect physical and if something breaks in financial stability it will affect it to others and if something is wrong with these three it will suffer growth and then what do we do about growth we we tend to discuss too many things in in isolation and therefore it's important to have a broader discussion and also to have better guidance towards for for the politicians you know as as much as as some they don't use an instrument but some for them for many of them they're very important so how can we have better metrics of how to conduct a public policy because otherwise the trust in government could suffer please join me in thanking Dr Carstens

Channel: Bank for International Settlements

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Id: PAamCXHXw70

Length: 80min 22sec (4822 seconds)

Published: Fri Apr 28 2023