global markets and macroeconomic policy responses ......global markets and macroeconomic policy...

Global Markets and Macroeconomic Policy ResponsesMacroeconomic Policy Responses to the COVID-19 Pandemic

Alberto Cavallo

Huw Pill

Dante Roscini

Matt Weinzierl

April 20201

Global Markets and Macroeconomic PolicyPolicy Responses

Faculty

2

AlbertoCavallo

HuwPill

DanteRoscini

MattWeinzierl

BGIE - Business, Government, and the International Economy


The Depth of the Crisis

3

US Great Recession – 2008-2009

Depth (peak-to-trough)

Great Recession 2008-2009 ~ 5%

Great Depression 1929-33 ~ 26%

On Tuesday, the IMF estimated that world GDP will fall by -3%, compared to less than -1% during the Global Financial Crisis

US


The Length of the Crisis

4

US Great Recession – 2008-2009Length

How long will this last?

The longer it takes, the more likely we will experience a permanentloss in output hysteresis Firm-employee connections are

permanently broken

Supply chains are disrupted

Some unemployed pull out of the labor force (discouraged, cannot invest in new skills)

Global trade / industries collapse

Quick policy reaction is needed


Why is this “the mother of all crises”?

5

Aggregate Demand

Aggregate Supply

Financial Crisis

Health Crisis

GLO

BAL

Containment fails, testing and other problems

Investors panic, forward-looking, asset prices and commodities collapse, capital outflows

Demand crisis as uncertainty rises, wealth shock, income shock, negative expectations future

Supply shock labor (lockdowns) supply chain disruptions

Affecting all countries


What can policy do about it?

6

Aggregate Demand

Aggregate Supply

Financial Crisis

Health Crisis Health Policy

Monetary Policy

Fiscal Policy

Global Policy

GLO

BAL

Global Markets and Macroeconomic PolicyPolicy Responses 7

Policy ResponseThe linked image cannot be displayed. The file may have been moved, renamed, or deleted. Verify that the link points to the correct file and location.

HuwPill


Policy responseMacroeconomic policy responses have the following intermediate objectives

• Keep financial markets functioning in the face of large and unexpected volatility

• Minimize knock-on impact of temporary demand weakness on the supply-side of the economy

• Support measures to increase capacity of the health care system

• Avoid a self-fulfilling collapse in confidence and spending which traps the economy in a depression-like state

The linked image cannot be displayed. The file may have been moved, renamed, or deleted. Verify that the link points to the correct file and location.


Central bank facilitiesCentral banks signal readiness to provide liquidity and market making

Under stress, traditional ‘market makers’ – now constrained by post-financial crisis regulation – no

longer provide market liquidity …

• Inject liquidity

• Reactivate special refinancing facilities

• Act as a ‘market maker of last resort’− ECB contains widening of intra-euro area spreads− Fed reactivates FX swap lines to other central banks

9


Dollar funding stressescross-currency basis, basis points

Year to date Long time series

globalfinancial

crisis

eurosovereign

crisis

Source: Goldman Sachs, Reuters

one measure of dislocation in financial markets


Recourse to Fed FX swapsUS$ billions, weekly

globalfinancial

crisis

eurosovereign

crisis

Use rises to over US$ 350bn

last week

Source: Federal Reserve Board

11


‘Bridging the valley’Avoid that temporary demand shortfall becomes permanent supply effect

• Activity is falling by design (‘lockdown’)• Avoid this (supposedly temporary) fall

becomes permanent because of ‘non-reversible’ effects hurting supply-side

− Bankruptcy of otherwise viable firms− Breaking of supply chains− Lay-offs of workers

− Repossession of homes

hysteresis /’scarring’


− Fed sets interest rate to zero− Government guarantees

loans− Regulators give regulatory

forbearance to banks

Replicating a“debt moratorium”= interest rate holiday

/automatic roll over of debt

In a crisis, revenue dries up: “cash is king”

Policy actionsCreate facilities for businesses to maintain economically crucial connections

But … Assumes a ‘V-shaped’ profile of activityIssues of eligibility and equity – is scheme seen as “fair”?Operational issues – can schemes be accessed quickly enough?


“The Speaker was encouraged by the Chairman’s perspective that, with

interest rates at nearly zero, Congress is enabled to fiscally think big as we craft a

robust response”Extract from the readout of call between Nancy Pelosi and Jerome Powell


Fiscal policy and COVID

15

MattWeinzierl


Composition of fiscal responseAn analogy with public health

16

Key steps

1. Treat the infected

2. Limit the spread

3. Protect us in the future

Public health

Raise hospital capacity

Impose social distancing

Testing+tracing, vaccine

Fiscal policy

Direct transfers, esp. to unemployed

Payroll support; temp. loans to firms, HHs

Unclear; not much discussed yet


The US example

17

Key steps


2. Limit the spread


CARES Act (more likely to come)• $300 B in direct transfers• $260 B in extended unemp. Insurance• $340 B to states for their expenses• $500 B in loans to large firms• $377 B in forgivable loans to small

firms

• Not really (though, some for public health, such as vaccines and tests)


Other prominent examples

18

Key steps


2. Limit the spread


Fiscal policy

• Hong Kong and Singapore: direct transfers to households

• Denmark: Government pays salaries (75% up to $3288/mo)

• France: Banks lend freely to businesses, govt backstops banks

• Australia: JobKeeper wage subsidy to sustain employment


Scale of fiscal response

• Recall two goals from before: 1. Minimize drop in

demand’s impact on supply-side

2. Avoid a self-fulfilling collapse in confidence

• Want to neutralize shock; restore pre-virus incomes

• In fact, we don’t want “stimulus”, so fiscal policy should replace income 1:1

• In US, if expected decline in GDP is 10-25%, and US GDP is ~$21 T, required scale is $2-5 T


Who can afford this scale?

• Government debt is not magic, it is borrowing from savers (at home or abroad)

• Debt can be good!• Savers are eager to

lend to countries they believe will repay with a strong currency

• US can borrow at near-zero rates; paying back 10-20% of GDP is fine

• Borrowing is much more expensive for countries not as trusted

• Many of these are also most at risk from disease

• Implies a role for the ECB, IMF (just acted)


Composition of fiscal responseAn analogy with public health

21

Key steps


2. Limit the spread


Public health

Raise hospital capacity

Impose social distancing

Testing+tracing, vaccine

Fiscal policy

Direct transfers, esp. to unemployed

Payroll support; temp. loans to firms, HHs

Unclear; not much discussed yet


One thought…• Fiscal policy matters

beyond macro• Taxes are how we fund

the state’s activities• Ideally, taxpayers trust

the government to spend their taxes well; we get a virtuous cycle

• So far, COVID suggests this virtuous cycle is not working everywhere

0

5,000

10,000

15,000

20,000

25,000

0 20 40 60 80 100

COVID deaths vs. trust in central govt


Emerging Markets

23

DanteRoscini


Emerging Markets

IMF – Great Lockdown

24


Quarterly World GDPQ1 2019=100

IMF

25


Emerging Markets


Great Implosion?: unique speed and synchronicity

26


Emerging Markets



Depressed commodity prices

27


Commodity PricesIndex, January 2, 2020 = 100

IMF

28


Emerging Markets




Collapse in global trade

29


Global Trade, 2015-2019Index, 2015 Q1=100 and year-on-year percentage change

WTO, UNCTAD

30


World Merchandise Trade Volume2000 – 2022E, Index 2015=100

WTO

31


Emerging Markets





Risk aversion: sudden stop in capital flows

32


Portfolio Flows to Emerging MktsUSD billions

IIF

33


Emerging Markets






Dollar strength

34


US Dollar IndexFrom 2015, Trade Weighted, 2006=100

Federal Reserve of St. Louis

35

Presenter

Presentation Notes

https://unctad.org/en/PublicationsLibrary/gds_tdr2019_covid2_en.pdf?user=1653

http://fred.stlouisfed.org/graph/?g=qJqa


EM Currencies Against the Dollar Q1 2020 vs Q3 2008 , Percent change

Reuters

36

Presenter

Presentation Notes

https://unctad.org/en/PublicationsLibrary/gds_tdr2019_covid2_en.pdf?user=1653


Emerging Markets






Dollar strength

Financial markets dislocation

37


MSCI EM IndexEquity Index

38

Datastream, GS


EMBI SpreadGlobal Diversified, bp

39

Datastream, GS


Emerging Markets - Issues

Reduced supply of foreign currency

40




Weaker import cover

41




Weaker import cover

Elevated dollar funding costs

42


EM USD Credit SpreadsIG vs HY Option-Adjusted Spread (bp)

Bloomberg, UBS

43




Weaker import cover


Higher refinancing/default risk on FX denominated debt

44


EM FX-denominated external debtex intercompany lending, USD billions

45

BIS, UBS, Haver


EM FX-Denominated Debt as % of GDPEx-Financials and Households, Q4 2019

46

IIF, National sources


EM Debt Redemption Schedule

47

IIF




Weaker import cover


Higher refinancing/default risk on FX denominated debt

More constraints in implementing defensive policies

48


Percentage of EM CBs Easing

49

Haver, UBS


Economic Policy ResponsesEM vs AE, Percent of Countries

50

IMF


Economic Policy ResponsesAnnounced Fiscal Measures in G20, % of GDP

51

IMF


WB


Emerging Markets - Tail Risks

Outbreak may take longer or return in waves

Deep recession might create longer-lasting costs

Downgrades and defaults may balloon

External relief might be insufficient

53


Emerging Markets - Questions

How to lay the foundations for recovery

What is the future of multilateral cooperation

How to reignite trade

How to reduce inequality

What are the political and geopolitical consequences

54


HBS Global Policy Tracker

55

www.globalpolicytracker.com

~25 HBS/Harvard Students

You can help! please visit the site to add policies in your country that our team can quantify and monitor over time

http://www.globalpolicytracker.com/


Thank you

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