The Covid19 pandemic responses: credit swaps and global fiscal cooperation.

Written by Luca Pagani

The Covid-19 advent started threatening the global economy massively in the first half of 2020, as countries, from East to West, announced strict lockdown measures. The beginning of this crisis reminded what the world experienced not even ten years before during the Great Recession. The strong similarity between the two downturns triggered today a response in line with what has been witnessed in Western countries from 2010 on. This symmetric behaviour is especially true for central banks, which have unleashed a series of measures closely related to the Great Recession’s response experience. This article analyses whether the use of “bazookas” money and swap lines among major central banks is sufficient as a response to the economic and health crisis brought about by the SARS-CoV2. It concludes that a more concerted action among fiscal and monetary policymakers is essential for defeating an economic downturn of systemic and exogenous nature.

The Covid-19 economic backlash led central banks to call in action instruments used during the 2008 financial crisis. Swap lines among the C6 (European Central Bank, Federal Reserve, Bank of Japan, Bank of England, Bank of Canada and Swiss National Bank) took hold in the form of backing the system especially with the provision of US dollars and reinvigoration of liquidity. As Bahaj and Reis (2018) highlight, swap lines guarantee a coherent flow of liquidity in the global financial system and allows banks to have their dollar-nominated assets backed by a consistent agreement among major central banks. Thus, the use of these tools is expected to be effective in the Covid-19 crisis, as it grants greater liquidity to commercial banks. This coordinated action was meant to support the large money injections and decreases in interest rates that central banks have announced in the first weeks of the month. The ECB has promised a Pandemic Emergency Purchase Program of €750b, increased by €600b on June 4th, meant to reinvigorate the liquidity and capacity of investors, banks and households, saying “there are no limits to our commitment to the euro”. On the same expansionary line, the Fed has cut interest rates to approach the zero-lower bound, in order to ease transactions and credit use for consumers. 

Undoubtedly these steps represent a crucial way forward in making access to liquidity more feasible for banks. However, hasn’t the era of “whatever it takes” come to an end? Doesn’t the zero-lower bound represent a point of no return for central banks ammunitions? The coordination witnessed in monetary terms across the globe in March 2020 is impressively fast, if compared to the time framework of the 2010 sovereign debt crisis. Nevertheless, the experience of the last economic crisis should make policymakers understand the cruciality of fiscal policy action (Wyplosz, 2020), especially given the wider time-framework through which these tools can operate. Hildebrand, in an FT article, underlines the importance of coordinated action between central banks and national governments to face such a pandemic crisis. As governments disburse tools to help households face the economic downturn, central bankers should guarantee the non-rise in interest rates “amid the largest natural disaster relief programme ever recorded”. 

Coordination is also essential in order to grant households access to commercial banks credit, through the use of credit guarantees by national governments. The sole action of granting liquidity bazookas to the banking system does not automatically translate in greater access to credit for firms and households. As outlined in a VoxEU column, over-indebted firms will likely see an enormous revenue collapse affecting workers and economic growth. This “cascading commercial sector” rescue goes beyond the action capacity of central bankers and asks for a coordinated governmental intervention. Fiscal stimuli in this sense could take the form of a financial backstop for firms, especially SMEs, and a (European-wide) programme to support short-employment protection (Garicano, 2020), both as means protect jobs.

This crisis is calling not only for a purposeful coordination among major central banks, to guarantee coherent response in monetary terms to an ever-globalised financial economy, but also for coordination among fiscal policymakers and between monetary and fiscal stimuli. In such a setting, Mehrling’s assertion on forgetting the G7 and focusing on the C6 exclusively, can be considered only partly right. Swap lines among central banks allowed a never-experienced level of coordination among the C6, which is likely to be extremely effective in liquidity terms during today’s economic crisis too. However, the Covid-19 pandemic for its exogenous character, requires an intervention also on a more political note. The G7 can have an important role in these terms, as a unique voice through which major political actors can call for timely and effective intervention of all economic and financial parts involved in the crisis (Wei, 2020).

Given the interconnectedness of today’s banking and financial world, governments, central banks and the commercial banking system need to act, globally, in a coordinated fashion. As Gordon Brown recently stated, these are unforeseen circumstances which require a perspective shift: institutional actors shall coordinate in their monetary, fiscal and financial policy responses, at European, transatlantic and possibly global level. The EU-led Covid-19 funding in May 2020 is a first important response to the perceived need of joining national efforts for a global challenge. However, this will not be enough. As of today, the virus is increasingly spreading to emerging and developing countries, where the consequences will likely be exponentially more devastating than in Europe.

As the summer approaches, countries in Europe are emerging from lockdowns, however still worried from a second wave coming in fall. The fiscal and monetary measures suggested above would and will have desired consequences on the economy, as long as a governments will not enforce lockdowns as strict as in the first part of 2020. In order to avert a second health and thus economic downfall European countries need to cooperate now, in the months seemingly less at risk. This means identifying the regions more at risk from a demographic and fiscal standpoint, and build up a coherent health capacity where necessary. An interesting study by Wyper et al. (2020) has successfully evidenced European countries and macro-regions more vulnerable in population terms. It highlights demographic weaknesses in some countries, whose study will be likely crucial for the avoidance of a second wave. The COST burden-eu Action is an extraordinary good example of data and research cooperation across European countries. We believe this project of having good probabilities of success, as theoretically it allows to match population vulnerabilities with weaknesses in the economic response, both in a preventive approach (e.g. new specific hospitals) and in a later one (targeted economic recovery plans). However, this will be implementable if the cooperation among countries goes beyond the research paradigm, and includes political and fiscal cooperation to face a risky second wave.

In conclusion, cooperation is most probably the only instrument governments have in their hands to deliver an effective global response to health and economic consequences of the Covid-19 crisis. EU countries have showed a rather intense cooperative action in the past weeks, even though the majority of the project foreseen still need to see an actual realisation. The search for a vaccine and the COST programme outlined above are good examples of how cooperation is producing positive outcomes. However, this is still limited to a  rather reduced scale. Emerging countries are going to need help from wealthy nations, and these latter must ensure this financial aid despite the difficulties at home. To avoid this conundrum, a global reach for financial cooperation and health research is necessary, so to better exploit the help from those countries with major fiscal capacities in the specific moment of need. This reach can be developed not only in monetary terms, as seen before in the C6 framework, but also fiscally, within the G7 or G20 setting, with the intervention of other international financial institutions, and medically, with larger and more targeted funds to the WHO.

References

Bahaj, S., & Reis, R. (2018). Central bank swap lines. CEPR Discussion Papers.

Brown, G. (2020, March 25). End the dog-eat-dog mentality to tackle the crisis. Financial Times. Retrieved from https://www.ft.com/content/ccbee0d6-6e94-11ea-89df-41bea055720b

European Central Bank, Directorate General Communications. (2020, March 18). ECB announces €750 billion Pandemic Emergency Purchase Programme (PEPP). Retrieved from https://www.ecb.europa.eu/press/pr/date/2020/html/ecb.pr200318_1~3949d6f266.en.html

European Central Bank, Directorate General Communications. (2020, March 20). Coordinated central bank action to further enhance the provision of US dollar liquidity. Retrieved from: https://www.ecb.europa.eu/press/pr/date/2020/html/ecb.pr200320_1~be7a5cd242.en.html

Danielsson, J., Macrae, R., Vayanos, D., & Zigrand, J.-P. (2020, March 25). The coronavirus crisis is no 2008. VoxEU.org. Retrieved from https://voxeu.org/article/coronavirus-crisis-no-2008

Garicano, L. (2020). The COVID-19 bazooka for jobs in Europe. In Mitigating the COVID Economic Crisis: Act Fast and Do Whatever It Takes (pp. 129–128). London: VoxEU.org.

Greeley, B., Smith, C., Samson, A., Rennison, J., Martin, K., & Ablan, J. (2020, March 15). Fed cuts US interest rates to zero as part of sweeping crisis measures. Financial Times. Retrieved from https://www.ft.com/content/a9a28bc0-66fb-11ea-a3c9-1fe6fedcca75

Hall, B., Arnold, M., & Fleming, S. (2020). Coronavirus: can the ECB’s ‘bazooka’ avert a eurozone crisis? Financial Times. Retrieved from https://www.ft.com/content/a7496c30-6ab7-11ea-800d-da70cff6e4d3

Hildebrand, P. (2020, March 24). Central Banks Must Evolve. Financial Times. Retrieved from https://www.ft.com/content/b8fa16c6-6d11-11ea-89df-41bea055720b

Wei, S.-J. (2020). Ten keys to beating back COVID-19 and the associated economic pandemic. In Mitigating the COVID Economic Crisis: Act Fast and Do Whatever It Takes (pp. 71–76). London: VoxEU.org.

Wyplosz, C. (2020). So far, so good: And now don’t be afraid of moral hazard. In Mitigating the COVID Economic Crisis: Act Fast and Do Whatever It Takes (pp. 25–30). London: VoxEU.org.

Wyper, G. M., Assunção, R., Cuschieri, S., Devleesschauwer, B., Fletcher, E., Haagsma, J. A., . . . Grant, I. (2020). Population vulnerability to COVID-19 in Europe: A burden of disease analysis. Archives of Public Health, 78(1). doi:10.1186/s13690-020-00433-y