BM: How does central banking change worldwide? Do we see that blurring of lines with fiscal policy?
KR: It’s fiscal policy that they’re doing in this emergency situation. You can’t imagine trying to get these same subsidies passed through the Senate and the House in real time. So central banks all over the world are using the fiscal side of their balance sheet. A lot of people don’t properly understand that governments own the central banks. And when the central bank uses its balance sheet, it’s acting as an agent on behalf of the government, whether it’s doing maturity transformation, which is what pure quantitative easing is, when it buys long-term debt, [or] it’s doing subsidies to the private sector by buying mortgages, by intervening in corporate debt, by intervening in municipals.
Ultimately I hope we don’t see a big change in central banks, but we’re probably going to need an expansion in finance ministries to take on and regularize and legitimize some of these responsibilities. Lastly I think we’re not in a position to use deeply negative interest rates because the preparation hasn’t been done. And you have to deal with cash hoarding. That’s a shame because I think that would have been a valuable instrument, and would have been helpful for some municipals and corporates, and would have reduced the number of patients going into bankruptcy court. Monetary policy is essentially castrated by the zero bound.
CR: Central banks were the arm of financing during two world wars, without question. I think you would have been laughed at if you really brought up the issue of central bank independence in the context of either world war. You really can’t separate the fiscal story and the debt story from the monetary story in extreme periods. Central banks began to do fiscal policy not just this time around, but they began to do fiscal policy in the 2008-09 crisis. We really can’t look independently at central banks without also looking at the balance sheet, not just of the government, but the balance sheet of the private sector, which has a lot of contingent liabilities.
On the issue of negative interest rates, I do not share Ken’s views on that particular matter. When you have, as we do today, very fragmented markets, markets that became totally illiquid, I think the way I would deal with that would not be through making rates more negative, but by an approach closer to the one taken by the Fed, which is through a variety of facilities that provide directed credit. Sustained negative interest rates in Europe have led to a lot of bank disintermediation. And often bank disintermediation means that you end up with the less regulated, less desirable financial institutions.
BM: There is some question over the future path of inflation. Do you see an inflationary surge at some point?
KR: We don’t know where we will come out. So the probability is, for the foreseeable future, we’ll have deflation. But at the end of this, I think we’re going to have experienced an extremely negative productivity shock with deglobalization. In terms of growth and productivity, they will be lasting negative shocks, and demand may come back. And then you have the many forces that have led to very low inflation maybe going into reverse, either because of deglobalization or because workers will strengthen their rights. The market sees essentially zero chance of ever having inflation again. And I think that’s very wrong.
BM: And what scars are left on economies once the pandemic passes?
CR: Some of the scars are on supply chains. I don’t think we’ll return to their precrisis normal. We’re going to see a lot of risk aversion. We’ll be more inward-looking, self-sufficient in medical supplies, self-sufficient in food. If you look at some of the legacies of the big crises, those have all seen fixed investment ratchet down and often stay down.
Kennedy is executive editor for Bloomberg Economics in London.