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Thematic Paper Covid-19 Central Banks Monetary policy
2.06.2020 61

The day after #5 - New Frontiers for Central Banks

Published 

2 June, 2020

> 10 minutes
2.06.2020
61
The day after #5 - New Frontiers for Central Banks
Published 

2 June, 2020

> 10 minutes

Abstract

Central Banks (CBs) are by nature more flexible than governments. Thus, they have been the most proactive in this crisis, reintroducing large-scale asset-purchase programmes financed by money creation (QE policies). With this pandemic, a spectacular change in economic policy has taken place in just a few months: fiscal and monetary policies have become intertwined, and this is probably not reversible. While governments have become the buyers of last resort, CBs are playing their role as lenders of last resort. How far can they go? We argue here that CBs are still far from being out of ammunition. Financial repression and fiscal dominance are here to stay. CBs will maintain low bond yields for an extended period of time to alleviate the burden on the most leveraged agents.

The structural weakness of nominal and real interest rates should lead investors to continue to ‘hunt for yield’; in particular, this environment should encourage households to diversify their savings away from government bonds. Ultimately, we cannot rule out the emergence of new bubbles, the bursting of which could jeopardise macrofinancial stability. Regulation and taxation may have to be mobilised to contain asset-price inflation, particularly with regard to property market. Unconventional monetary policies call for more regulation, not less.

CBs will continue to provide liquidity as much as needed and to combat financial fragmentation. However, CBs alone cannot be expected to do the impossible; they can neither absorb on their own the increased economic fragmentation resulting from the crisis, nor even prevent companies in certain sectors from defaulting or even going bankrupt.

We believe that global reflation is at hand with the right policy mix. However, should the crisis deepen and deflationary pressure intensify, CBs would probably not hesitate to explore new avenues, of which all may have unwelcome side effects. We have to prepare for it and thus ‘think the unthinkable’: full-blown debt monetisation, helicopter money, debt cancellation or even very negative nominal interest rates.

 

To find out more, download the full paper 

 

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