sign uplog in
Want to go ad-free? Find out how, here.

Paola Subacchi cautions against relying on central banks to lead the economic rescue and recovery effort

Paola Subacchi cautions against relying on central banks to lead the economic rescue and recovery effort

With output having collapsed as a result of the COVID-19 pandemic, many are wondering how far monetary policy can be stretched to support the economy. For the US Federal Reserve, negative interest rates appear to represent an effective limit, not because such a policy is technically unfeasible, but because it would be politically unacceptable. Yet for the European Central Bank, the Bank of England, and the Bank of Japan, there appears to be no limit.

The ECB has long since cut rates into negative territory, and BOE Governor Andrew Bailey is reportedly “looking very carefully” at that option for the United Kingdom. Likewise, BOJ Governor Haruhiko Kuroda, while deeming the BOJ’s current policy mix appropriate for current conditions, has not ruled out further monetary easing or another increase in asset purchases.

The question is whether it makes sense to go further down the road of extreme monetary policy. Former ECB President Mario Draghi’s famous promise to do “whatever it takes” to support the euro has now become the mantra for all policymakers confronting the current crisis. But wouldn’t expanding fiscal policy be a better way to fulfill that commitment? To paraphrase Fed Chairman Jerome Powell, central banks have lending power, not spending power – and spending is what is needed.

In the current crisis, it is imperative that money reach those most in need as quickly as possible. Unemployment is at a record high in many countries – more than 20 million people in the United States lost their jobs in April alone, pushing the US unemployment rate to 14.7%, and putting it on track to reach 20-25% this year. Under these conditions, what the US and most other countries need is a broad, sustained fiscal-policy push, undertaken in coordination with monetary policy. Without that, a prolonged recession and sky-high long-term unemployment will become much more likely.

A fiscal expansion should have two primary objectives. First, it must help individuals, households, and firms weather the crisis. In this respect, the fiscal-policy measures adopted in the US and other advanced economies have been on the mark. In late March, the US Congress approved a $2 trillion stimulus package to support households, firms, and health-care providers, and Democrats in the House of Representatives have now passed another package proposing $3 trillion in additional spending.

Meanwhile, in the European Union, budget rules have been suspended, allowing member-state governments to pursue more ambitious discretionary fiscal measures, from spending increases and tax relief to wage support and subsidies for small and medium-size enterprises.

The second objective of fiscal expansion is to drive economic recovery by supporting domestic demand. Here, unfortunately, the policies on offer have fallen far short, raising the risk that we will repeat the mistake made after the 2008 global financial crisis, when fiscal stimulus was withdrawn too soon.

On that occasion, relying on fiscal policy to stimulate demand was declared politically unfeasible. Although the downturn was still considered large enough to warrant exceptionally loose monetary policies, the political establishment in the US, Britain, and much of Europe coalesced around austerity, smothering the recovery in its cradle and setting the stage for rising inequality and social discontent.

This time around, the major central banks have been quietly pushing for “additional fiscal support” in order to “avoid long-term economic damage” and bring about a “stronger recovery.” Such support is also needed to alleviate the pressure on central banks. Meanwhile, there are good reasons to avoid going down the road of more extreme monetary policy.

For starters, extreme monetary policies tend to limit the scope for future policy signaling and reduce the effectiveness of interest rates, which, under normal conditions, are powerful tools for influencing output and employment. Second, they could exacerbate the pre-pandemic vulnerabilities that were already threatening the world economy, not least the build-up of debt, the misallocation of credit, and excess liquidity in the corporate sector (where too many firms have problematic balance sheets).

These concerns lead to the third point: the further easing of credit conditions and expansion of public-supported credit programs could push more debt onto firms that are in no position to turn it into value. Bankrupt “zombie” firms would be kept artificially alive. Even if such measures preserved jobs for now, that doesn’t mean they are the most effective use of financial resources. Japan’s “lost decade” should serve as a cautionary tale. The longer zombie firms stagger on, the greater the losses will be when they eventually collapse.

Finally, relying on monetary policy when fiscal policy would be more appropriate risks reinforcing investors’ excessive preference for liquidity, thereby deepening the liquidity trap. It should go without saying that extreme monetary policies can generate extreme and unexpected consequences. Though unconventional monetary policy has now become the norm, we still are not quite sure how it works, or how it affects people’s expectations and behavior.

To be sure, if the scope for monetary policy is limited, the space for fiscal policy is also narrow. But the current emergency and the threat of a deep recession (or even a depression) undoubtedly calls for bold, “unconventional” fiscal policies supported by other tools, such as the European recovery fund that France and Germany recently proposed, and innovative capital-market instruments like perpetual bonds, which have also been proposed for the EU.

Exceptional times demand exceptional measures. But we must avoid repeating the mistake made in 2010, when governments slammed on the fiscal-policy brakes while keeping the monetary-policy engine in high gear. Now more than ever, it is imperative to prevent existing inequalities from deepening further. Only fiscal policy can advance that goal.

Paola Subacchi, Professor of International Economics at the University of London’s Queen Mary Global Policy Institute, is the author, most recently, of The Cost of Free Money. Copyright: Project Syndicate, 2020, and published here with permission.

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.


ANZ Bank is urging business owners not to stick their heads in the sand during the coronavirus crisis and warning those who know they won’t recover to take action now, while they can still realise some value from stricken businesses.
“For some business owners, the smartest thing for them to do is to wind it up now, and walk away with some equity,”

Good advice, for many kinds of 'business' owners.


Just to put things into perspective: Bank of #Japan owns almost 80% of all ETFs domiciled in #Japan. (via DB) Link

The Sovietisation of the economy.Link

"The establishment of a central bank is 90% of communising a nation" - Vladimir Lenin

What is the $value of the RBNZ's ultimate end game here?


Funny - and the capitalist right wing voters in NZ will say 'I hate those damn communists they're destroying the country' but please yes continue to make the value of my asset portfolios rise, I might go out and buy another rental.

And of course that other rental will have tennants in it getting either WFF or full rent subsidies... bloody communists!

Exactly - their dirty little secret is they love it while it financially benefits them - but publicly they are above it.

I tried to believe that the austerity policies pursued post GFC weren't infact deliberately implemented as a way of entrenching inequality and neoliberalism. The result of those policies suggest they were absolutely aimed at shattering the postion of the public sector and those it was supposed to protect. Afterall, business never likes to waste a crisis and the plentiful advantages such an event presents to those with capital over those without only underwrites my suspicions. Here in NZ our local interest rates were sky high compared to those available to foreign investors who logically joined our 'success story' of an economy and vacumed up many many high value assets, from property to companies. The result being the mess our Country and economy has been in ever since. The Covid collapse that is yet to manifest itself in all its apocolyptic might will go one of two ways. More entrenchment of inequality and further consolidation of the neoliberal framework OR when rebuilding after the bonfire that is to come, establishing a more equitible economic framework for all to participate in. Of course, surviving whats coming down the pipe shortly will be the key priority for nearly all of us. Hold tight, this will be rough!

The link between free education in construction and the building of new homes will be interesting to watch. If the state also becomes the banker to low interest loans then equity balances debt balanced by circulation of currency through supply. Only forestry remains to provide materials.. oh.. hang on..

Only economy left in the world is Monetary and Fiscal policy and future survival of economy and also of politicans depends on it. So come one come all and print the money.

Go to any mall and will be hard to tell that economy has just been hit by recession / corona virus...thanks to easy and free money.

But also.. take a population of people used to certain habitual freedoms. Constrain those freedoms for a while, then loosen the constraints.. the result will always be overreaction. People will be spending now whether they can afford it or not.

'The Level of Extreme Covid19 Monetary Policy'

No limit as one should not forget that we are in election year. Also this is just the begining of step towards Extreme, wait till election time.

aren't you confusing monetary policy (reserve bank) with fiscal policy (Govt). Surely Reserve Bank is operating outside party politics

More conventional thinking from the dark ages. Where's the thought that monetary policy should not benefit bond dealers and the rest of the financial sector. Where's the thought that fiscal policy funded by bond sales simply increases the rake off of taxpayer money into the already overflowing pockets of bank shareholders and rich investors. Where's the thought that monetary policy could directly fund fiscal policy to get economies out of the current hole thereby keeping government debt low (owing money to the bank you own is simply borrowing from yourself).

I think we're likely stuck in a liquidity trap now regardless - so unless we start defaulting on some debt somewhere in the system we either going to

a) struggle, or

b) struggle.

We can chose whether it is short or long though and it looks like our can kickers have decided we'd rather experience pain over the long term than short term. Fine I say...will go and buy some more panadol.

"Where's the thought that...."
It's on the streets; right now, across the World. From Hong Kong to Minneapolis and London.
It's at the front of minds of peoples who have latched onto the first excuse provided to fight back against the notion that "You too, can be rich like me if you just hock yourself to the eyeballs to achieve that". And in so doing, they don't enrich themselves, but those who push such social propaganda.
The World is indeed, thinking...and as it does, it's doing 'whatever it takes' to express its view. And if that involves brick, torches and chaos -then that's what happens when you suppress a society(s) with financial hardship.
We are reaping what we have sewn for 40+ years, and it is going to surprise and shock many.
But not anyone who chose to look at what a bleak future we had without change.

"We are reaping what we have sewn for 40+ years"

It's 49 years to be precise:

Wow - that is a great series of charts. Thanks for sharing.

The Us peaked conventional oil in 1970. Nixon abandoned gold ditto. Kissinger - the smartest of them all - indexed oil to the USD. The '68 arab/israeli war couldn't hit the US. The '73 embargo slammed them. And it's been downhill ever since. We are just watching the end-game; the acceleration as it got hit by an 'event'.

Yet there are a lot - perhaps the majority, who chose to believe 'gdp' and who by doing so, believed we have been ' growing' ever since. And some of them are those who report things.....

Great charts! From gold standard to fiat.. makes me wonder about bitcoin all over again..

Scarcity, immediately transferable, provable, portable, quantitive hardening, decentralised, open, secure, immune from outside interference. Bitcoin solves all of the problems on those charts.

Certainly illustrates the falsehood of the idea that things have always been the same and folk today just need to knuckle down. Perhaps they need to knuckle up and deliver them as sandwiches instead.

Presumably if much of the world goes to negative interest rates and we don't our currency will strengthen. Which isn't good for our exports.
Personally I think the OCR will be negative by the end of this year.

Pretty sure the Fed have come out and said no negative rates in the US - yet RBNZ are still toying with the idea. So NZD/USD, we could be negative and they're not. Not sure how that would leave us against the USD...

Well neg rates never happened here post gfc infact it was quite the opposite. Since we are a highly profitable extraction source for the global banking system I can understand why we never had negative rates, someones gotta prop up the balance sheet! As the covid collapse unfolds I think we will see negative rates here too. Which could work out really well for anyone wanting to invest capital into their business to update outdated equipment etc...

I'm not sure this article is particularly relevant to NZ.

Certainly we have had QE and a cut in OCR but more significantly we have had biblically large amounts of fiscal stimulus in order to slow the Ue we are expecting to balloon as the economic effects of the policy we and others have enacted. Debt to GDP is forecast to be 85% by 2023 from 30% pre Covid. That's some fiscal spend.

The most relevant question today that NZ is asking itself is how quickly we can move to level 1 and continue to reopen our businesses. Next will be the question of the Tasman bubble.

Central Banks are dysfunctional organisations as their responses are skewed in one direction due to political pressure and the centralization of power. The mandates under which they operate also remove the necessary discipline on governments to make the hard decisions, instead allowing ideology to influence decisions. Interest rates and credit creation should be determined by markets with market participants bearing the risk.

Let me guess - you think the concept of a free market and unlimited growth is (was, now) possible forever on a finite planet, is not ideology?

It's the thing we replaced pie-in-the-sky-when-you-die with; pie now if you just hock your future (to us). PS don't look but the ship is sinking - just sign here, move along....

They are determined by the bond market, low or zero growth is baked into the yields. As PDK says.....

I reckon we are in a deflationary feedback loop, cheaper money is not making us (or encouraging us) to spend more , quite the reverse .

Mr Orr is making a fundamental error, and would do well to realize that savers have a higher propensity to save when yields are very low .

And we have evidence of this.

What did the Japanese do when interest rates got to zero ?

Did they spend up large ?


Here in NZ , people like me ARE NOT SPENDING and do not intend to start doing so , so cheap money will not encourage us to spend .............quite the reverse

We Boomers are saving for our retirement, and ultra low rates may perversely be driving a greater propensity for consumers to save as retirement income becomes more uncertain.

So , he has got it completely wrong in my view .

Does he even understand this ?