The central banks’ unconventional monetary policies, originally implemented in the wake of the global financial crisis of 2008, have now been re-introduced during the ongoing crisis caused by the coronavirus pandemic. This time, however, we can clearly see the growing role of central banks in financial markets — not only in their previous role of lenders of last resort, but also in the role of market makers.
A large portion of the asset purchases carried out by central banks as part of their monetary support programs applied to government bonds. The terms of these programs have now been relaxed — this has been the case, for example, with the Pandemic Emergency Purchase Program conducted by the ECB. As a result of the undertaken monetary policy measures, long-term interest rates in developed economies remain low, even amid the increasing issuance of public debt.
The International Monetary Fund projects that in 2021 the median debt of developed economies will increase by about 17 per cent of the GDP due to the need to finance programs that stimulate economic activity. Further financial assistance packages for the economies are also possible — such as the currently discussed new fiscal stimulus in the United States.
The continued absence of inflationary pressures means that there is no pressing need to slow down the rate of growth of central banks’ balance sheets or to raise short-term interest rates. This also means that the costs of financing public debt remain low.
As interest rates are low, it is cheaper for national authorities to borrow money on financial markets, among other things, to finance the development of new infrastructure — such as, for example, investment projects in the area of medicine or investments in a low carbon economy — which is ultimately supposed to stimulate economic growth and counteract threats related to health and climate.
However, in the event of an unexpected rise in inflation the entire structure of the state debt would be put at risk, because central banks would be forced to raise their interest rates and to pay high interest on the new reserves created for the purpose of purchasing government bonds.
Greater role of the state in the economy
One important feature of this year’s anti-crisis measures is also the increased role of fiscal authorities which have become lenders of last resort, especially for the enterprise sector. As a result, national authorities have started to play a much more active role in the economy when it comes to capital allocation.
For example, the United States’ Federal Reserve and the Treasury Department together hold nearly one-tenth of all US corporate debt (with a total value of approximately USD3.9 trillion) purchased under the anti-crisis assistance programs.
We should keep in mind that public financial support for private enterprises, even when it is provided pursuant to clearly defined rules, may contribute to a distortion of the existing principles of market operation and could lead to moral hazard.
Trust is crucial
We still don’t know much about the effectiveness of anti-crisis interventions as well as their possible duration. A key factor enabling a country to emerge from a crisis is the level of trust among all stakeholders — the participants of economic life. However, in recent years, in many developed countries the level of public confidence in governments, as well as public and private institutions, has been falling. One current manifestation of this trend is a sharp rise in the prices of gold in recent months.
Additionally, the ongoing crisis is very ambiguous — at the same time when the threat to public health was intensifying and triggering economic collapse, financial markets were booming. This is one of the reasons why the pandemic crisis, like the previous global financial crisis, has significantly weakened public confidence in expert knowledge, giving rise to many conspiracy theories and rhetoric rejecting science.
The unprecedented scale of the anti-crisis mobilization of financial resources by central banks and fiscal authorities has illustrated the tremendous potential of finance in protecting or re-orienting entire economies. However, such a situation can only last as long as there is sufficient and enduring trust among the participants of economic life. Otherwise, the crisis will be prolonged and in an even more negative scenario featuring, for example, a dramatic loss of confidence in central banks, it could even threaten the stability of the global financial system.