Central Banks Must Address Pandemic Challenges

Yves here. Most Naked Capitalism readers hail from advanced economies, so we have only a dim and partial view of how developing economies, or alternatively, the Global South, are coping with Covid, and then mainly on disease outbreaks. These countries are also contending with economic damage, and many also get bad advice about what to do. This article tries to remedy that by describing how central banks historically played an important role in national development, and have more latitude to do so now than is commonly thought.

By Anis Chowdhury, Adjunct Professor at Western Sydney University and University of New South Wales (Australia), who held senior United Nations positions in New York and Bangkok and Jomo Kwame Sundaram, a former economics professor, who was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought. Originally published at Inter Press Service

Hopes for an inclusive global economic recovery are fast fading. As rich countries have done little to ensure poor countries’ access to vaccines and fiscal resources, North-South “fault lines” will certainly widen.

Enhancing Relief, Recovery, Transformation

While the International Monetary Fund (IMF) has revised rich countries’ recovery prospects upward, the United Nations (UN) notes formidable challenges, especially for developing countries, due to the pandemic.

The UN warns of more setbacks for the Sustainable Development Goals (SDGs), already behind schedule before the pandemic. Grim recovery prospects have been worsened by debt distress and dramatic drops in investment and trade.

Designing appropriate relief, recovery and reforms well is necessary. For the IMF, growth-enhancing reforms could significantly improve growth in emerging market and developing economies over the next decade.

Countries must quickly spend much more to contain the pandemic and offset adverse effects of policy responses. This is needed to protect incomes, jobs and businesses, while paying more attention to the most vulnerable. Also, the SDGs still need more financing.

Policy choices now will determine chances of a greener, more inclusive and resilient future. There have to be better synergies among short, medium and long-term policies through improved coordination.

Macroeconomic Policy Coordination

Although public debt is already high while tax revenue has shrunk, governments need to spend more. Central banks (CBs) must lend more to governments to create more fiscal space. Better monetary policy support for government spending should strengthen relief, recovery and reform, not enable more corporate debt and asset price bubbles.

In turn, fiscal authorities can create monetary policy space by enabling spending on nationally produced goods and services, investing in productive capabilities, enabling new jobs and occupations, and expanding social protection. Policy design should ensure that more liquidity does not generate excessive inflationary pressures or net imports.

Greater CB independence in recent decades has undermined macroeconomic policy coordination, preventing them from lending directly to governments. Keeping inflation low has become paramount, ignoring other policy goals. Supposedly for CB and monetary policy credibility, such priorities actually serve financial investors, especially speculators.

But with ‘unconventional monetary policies’ after the 2008 global financial crisis, CB lending to governments has become more acceptable. Many rich country governments have since turned to central banks for fiscal space and other finance.

With little affordable finance available from both private and official sources, some developing countries, such as Indonesia, have temporarily suspended laws preventing direct borrowing from central banks. Others, e.g., the Philippines, have amended legislation to allow central banks to directly lend to governments.

Thus, how countries emerge from recessions in the short-term, and transform their economies to achieve progress in the longer term, critically depends on effective cooperation between central banks and governments.

Central Banks’ Developmental Role
Historically, central banks have played a developmental role, e.g., financing public investment. Even though many CB statutes are not explicit about such roles, the two oldest central banks – the Bank of England and Sweden’s Riksbank – are not prohibited from vigorously promoting policy priorities, e.g., the latter’s commitment to housing for all.

The Bank of England has even pioneered creating specialised development institutions, e.g., the Industrial and Commercial Finance Corporation, the Finance Corporation for Industry, and the Bankers’ Industrial Development Company.

The US Federal Reserve Act is committed to realise “the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates…in furtherance of the purposes of the Full Employment and Balanced Growth Act of 1948.”

Central banks of Italy, Germany, Japan and the Netherlands have used various means to finance activities underserved by credit markets. These include lowering bank reserve requirements and lending for priorities such as housing, agriculture, exports, small business and underdeveloped regions.

Well before independence, the Reserve Bank of India observed, “it may be desirable for Central Bank credit to be made available in a larger number of ways and with less restrictions”. Hence, development objectives are explicit in many developing countries’ CB statutes.

The statutes of some central banks established in the 1970s and 1980s with IMF technical assistance also have specific provisions for developmental roles, e.g., in Bhutan, Botswana, Fiji, Maldives, Solomon Islands, Swaziland and Vanuatu.

This is consistent with IMF Article of Agreement IV, “each member shall endeavor to direct its economic and financial policies toward the objective of fostering orderly economic growth with reasonable price stability, with due regard to its circumstances”.

The Bangladesh CB, a financial inclusion pioneer, also adopted a sustainable finance policy in 2011 to promote green investment and sustainable agriculture. Ninety developing country central banks have since signed the Maya Declaration to advance financial inclusion.

Supporting Transformation
Borrowing to finance recovery and reform has to promote desirable changes, creating new productive capacities, accelerating digitalisationrevitalising rural and regional economiesconducting business and work in new ways, and making economies more sustainable.

The European Central Bank (ECB) has aligned ‘quantitative easing’ with the European Commission (EC)’s pandemic response. By indicating it would buy newly issued government bonds in the secondary market, the ECB has effectively financed government borrowing despite the ban on directly lending to the government.

Thus, considerable ECB purchase of government bonds has lowered borrowing costs for member States’ pandemic responses. These include the EC’s Next Generation package, including the European Green Deal and its ‘digitalization transition’.

The Bank of Japan is also supporting government efforts for relief, recovery, economic growth, structural change, disaster management and global warming mitigation. It is also encouraging companies to invest in digitalisation and green technologies.

The South Korean CB has also purchased more government bonds. Several measures have provided monetary support for the ‘Korean New Deal’, including pandemic relief, recovery, digital and green investments, and employment safety nets.

China’s CB’s targeted monetary policy tools are also increasingly aligned with the government’s long-term strategic goals. These include supporting key sectors while preventing asset price bubbles and ‘overheating’.

Bolder Actions Needed

Over the last year, poorer countries have been condemned to protracted recessions and delayed recoveries. Vaccine imperialism and apartheid mean that their vaccination efforts will be delayed and limited, if not worse.

Extended slowdowns not only threaten to become depressions, but also to further set back the modest progress achieved in recent decades. The North-South gap between rich and poor countries is certain to grow again.

Recovery prospects have been set back by poor countries’ lack of ‘fiscal space’. The IMF must help them use monetary policy much more creatively, not only to enhance fiscal space, but also to complement other policies for relief, recovery and transformation.

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  1. ChrisFromGeorgia

    Most developing countries central banks cannot engage in large scale printing (referred to by the author as ‘lending directly to governments’) without risking currency crises … or so I thought?

    My understanding is that privilege is limited to places like the US, China, Japan and the EU with large enough economies to get away with it, at least for the time being.

    1. Louis Fyne

      yes. and all the examples that OP listed are reserve currencies (EUR, USD) or currencies with BIG central bank rainy day funds that allow those countries to manage their currencies (PRC, Korea, Japan).

      Developing countries, even with devalued currencies, will still need petrol, pills, microchips, car parts all priced in EUR or USD.

      Unless (see Tegnost’s comment), the author is unintentionally calling on developing countries to deflate their currencies to make it easier non-local investors to swoop in and buy up local assets.

      The only path is local/regional sourcing of production (to the extent possible), not financialization

    2. praxis

      Developing counties need some sort of a mixture of capital controls, domestic industrial policy plus hefty import consumption taxes to be able to print money without getting hammered.

      1. Susan the other

        One way to establish logical “fiscal space” would be to allow the whole concept of the “value” of money to be retroactive. After all that is not a new concept because interest is paid after the use of the money, and assumes the money allows the necessary production to service the debt, etc. So with that obvious common sense attitude it would be a short step to simply codify “fiscal space” as easy money for good long term benefit. So instead of looking at a poor country with a piddly little bank as a bad risk and punishing them up front with harsh terms, all money should be looked at as potential money. If it increases the value of society the money itself increases in value and the exchange rate between the piddly bank and some big fat bank should narrow. So logic almost dictates that poor countries that need lots of things are potential gold mines compared to overdeveloped and over-rich countries who have already gobbled up most of their former “fiscal space” already.

  2. tegnost

    Wow, what a great opportunity to purchase developing countries, now that the IMF has a bad reputation for fleecing the sheep, oops, I mean patentable productive capacity.

  3. chuck roast

    So, I click on the IMF link. Here are the IMF “growth enhancing reforms” recommending for “developing” countries:
    “Enhanced debt restructuring mechanisms should help resolve unviable firms expeditiously and channel investment to new ideas and companies. Stronger active labor market policies , including job-search monitoring and support, and retraining should help workers shift to more promising jobs in dynamic parts of the economy. Improved competition policy frameworks —actively debated right now in Europe and the United States—and reductions in barriers to entry in sclerotic sectors should ensure that we don’t have moats around the firms that captured the policymakers of yesteryear.”

    This is ivory tower economic claptrap if I ever heard it. No mention of Cuba? Cuba, the socialist country firmly outside the Ptolemaic orbital claptrap? Cuba, the country living under a crushing imperial economic embargo for 60 years? Cuba, the country that apparently has independently developed its own Covid vaccine? Cuba, the country that Wassily Leontief assisted early on with his input/output analysis? All hail Bengladesh and Vanuatu!

  4. flora

    Recovery prospects have been set back by poor countries’ lack of ‘fiscal space’. The IMF must help them use monetary policy much more creatively,…

    um, like in … Greece? / ;)

  5. rjs

    trouble is, this pandemic is happening faster than economists can write it down…during the week the IMF was considering how much worse off the global south was doing, the US suddenly had more new cases than India, Brazil and Iran combined….

  6. advait

    Anis Chowdhury is deeply stuck in a quagmire of neoliberal nonsense. The US, Canada, Japan, Australia, UK, Sweden, NZ, South Korea, India, etc. etc. many more, all have full monetary sovereignty (FMS). That means that, on a national level, their taxes in no way, shape or form fund national spending. From an accounting perspective, all their national taxes are destroyed upon payment. All national spending is the creation of new money. These are facts you can verify.

    All these countries can purchase whatever is for sale in their currencies (including all unused labor). These governments have no need whatsoever to ‘borrow’ money when they can create all the money they need out of thin air (by typing numbers into spreadsheets). They have no need to ‘borrow’ from the CB. Public debt is private surplus. The private surplus is simply money spent into the economy by the national govt that has not been taxed back. Elimination of public debt = elimination of private surplus = economic disaster for the whole economy.

    The only limit is real resources in the real economy (aka ‘inflation’). Any country with FMS can easily create a National Job Guarantee offering a decent paying job (with full benefits) to anyone who wants it. Thus the total elimination of poverty. Easy to do. They can fund free and decent healthcare and education for all. That’s the power of FMS. That power has nothing to do with being or not being a ‘reserve currency’.

    All this was explicitly confirmed by Alan Greenspan in his famous response to Paul Ryan. You can watch it on youtube.

    PS; All the countries in the Eurozone gave up their amazing power of FMS, much to the delight of powerful corporations and wealthy plutocrats. Lack of FMS makes it easier for governments to eliminate social welfare programs and push for predatory privatization. Once again, in the Eurozone, the oppressed happily voted for their oppressors.

    PS: Yes, many countries do not have FMS or have only partial monetary sovereignty.

    PS: The IMF will gladly loan money to developing nations (thus reducing their monetary sovereignty). But the IMF will never support policies to help them get to FMS aka monetary independence.

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