The pandemic has pushed central bankers to the forefront of economic policy, intervening in markets with unlimited firepower and financing enormous government budget deficits.
Now with the possible end of the pandemic coming into view, and a depression-order global economic collapse apparently averted, an exit strategy is urgently needed, says BlackRock vice-chairman and former Swiss central bank chief Philipp Hildebrand.
“Ultimately, central banks need independence again, so they can begin to react when inflation expectations change,” Mr. Hildebrand said. “The risk is that you lose control of inflation expectations, which is the anchor of the whole monetary system we’ve had in place for the last 30 or 40 years.”
The Globe and Mail spoke with Mr. Hildebrand about the need to plan a transition now, with inflation pressures starting to build.
Do we have a handle on what the total economic damage of the pandemic is likely to be?
We do, contingent on the assumption we get a vaccine working by early next year. Postfinancial crisis, in the eight years from 2008 onward, the U.S. had about a 50-per-cent cumulative shortfall in GDP. In Europe, it ended up being almost 120 per cent over 10 years, because of the euro crisis. I think this time it’s going to be significantly less, something like 20 to 25 per cent of GDP in the U.S., maybe 30 per cent in Europe. Even taking into account some of these second-wave lockdowns, the damage is still going to be a fraction of what it might have been or what it was after the financial crisis.
What gets credit for limiting the damage?
It’s a combination of supporting the labour market and using fiscal measures to sustain businesses that are basically viable. That was a very important piece that prevented bankruptcies. So we avoided having a financial crisis on top of everything else. It’s building a bridge. And now that the vaccines look like they’re coming, it turns out that we have built a bridge to somewhere.
What will be the main takeaway from the global central-bank response? Did they get it right?
We thought what we did in 2008 was extraordinary. But it pales in comparison to the COVID response. The total announced measures by the [U.S. Federal Reserve] in April, within a span of a couple of weeks, was more than double the amount that was done in the five years following 2008. It was more aggressive by orders of magnitude. I think the overall conclusion will be that it worked. We didn’t have a meltdown, we didn’t have a great depression, we didn’t have a financial system that ceased to work. But we also know that it has exacerbated a number of problematic trends, not least of which is wealth inequality. The other big consequence is that there has been a blurring of the boundaries between fiscal and monetary policy, which may end up being the biggest legacy piece of this policy response. How do we put that genie back in the bottle?
Is there a plan?
Not yet. The legacy of what we’ve done collectively will be a function of whether we can successfully engineer that transition. I think we’re moving into a new era, which will see higher inflation. If I’m right, we need to unblur the lines so that inflation expectations don’t come unanchored. That will be the great challenge.
Why do you think inflation is underestimated?
Right now, central banks have strategies where they deliberately tend to overshoot inflation. There are also a number of supply shocks to the global economy. One of them is a pivot to sustainability. Another is building a more resilient global supply chain. Both of those will increase production costs for perfectly good reasons.
Why will it be such a big challenge to revert to traditional central-bank mandates?
Debt levels have gone up quite substantially. The OECD average is probably running at 120 to 130 per cent of GDP. As inflation rises, the question is what happens to rates, and then what happens to the servicing costs of that debt. There will be a lot of pressure to keep the central banks in the game of preventing rates from rising. Do we let the central banks gradually and carefully do their job, once you start to see this inflation dynamic change?
Does the accelerated timeline on COVID-19 vaccines give central banks the opportunity for an earlier exit strategy?
Yes. But it also makes it more urgent to put up guardrails, to put a framework in place between politics and central banking. It’s going to be a challenge on the political side to have the foresight and the wisdom to understand that.
Is there now a monetary-policy playbook for how to deal with a pandemic?
Yes, provided we can also get the exit right.
On the fiscal side, how do governments deal with all of this public debt?
The amount of money being poured into economies all over the world is quite extraordinary. We’re going to face consequential policy challenges around how all this public money gets administered and how we can use it to elevate growth. We need to grow our way out of this big debt hangover.
This interview has been edited and condensed.
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