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
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AlbertoCavallo
HuwPill
DanteRoscini
MattWeinzierl
BGIE - Business, Government, and the International Economy
Global Markets and Macroeconomic PolicyPolicy Responses
The Depth of the Crisis
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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
Global Markets and Macroeconomic PolicyPolicy Responses
The Length of the Crisis
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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
Global Markets and Macroeconomic PolicyPolicy Responses
Why is this “the mother of all crises”?
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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
Global Markets and Macroeconomic PolicyPolicy Responses
What can policy do about it?
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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
Global Markets and Macroeconomic PolicyPolicy Responses 8
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
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Global Markets and Macroeconomic PolicyPolicy Responses
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
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Global Markets and Macroeconomic PolicyPolicy Responses 10
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
Global Markets and Macroeconomic PolicyPolicy Responses
Recourse to Fed FX swapsUS$ billions, weekly
globalfinancial
crisis
eurosovereign
crisis
Use rises to over US$ 350bn
last week
Source: Federal Reserve Board
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Global Markets and Macroeconomic PolicyPolicy Responses 12
‘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’
Global Markets and Macroeconomic PolicyPolicy Responses 13
− 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?
Global Markets and Macroeconomic PolicyPolicy Responses 14
“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
Global Markets and Macroeconomic PolicyPolicy Responses
Fiscal policy and COVID
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MattWeinzierl
Global Markets and Macroeconomic PolicyPolicy Responses
Composition of fiscal responseAn analogy with public health
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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
Global Markets and Macroeconomic PolicyPolicy Responses
The US example
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Key steps
1. Treat the infected
2. Limit the spread
3. Protect us in the future
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)
Global Markets and Macroeconomic PolicyPolicy Responses
Other prominent examples
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Key steps
1. Treat the infected
2. Limit the spread
3. Protect us in the future
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
Global Markets and Macroeconomic PolicyPolicy Responses 19
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
Global Markets and Macroeconomic PolicyPolicy Responses 20
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)
Global Markets and Macroeconomic PolicyPolicy Responses
Composition of fiscal responseAn analogy with public health
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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
Global Markets and Macroeconomic PolicyPolicy Responses 22
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
Global Markets and Macroeconomic PolicyPolicy Responses
Emerging Markets
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DanteRoscini
Global Markets and Macroeconomic PolicyPolicy Responses
Emerging Markets
IMF – Great Lockdown
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Global Markets and Macroeconomic PolicyPolicy Responses
Quarterly World GDPQ1 2019=100
IMF
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Global Markets and Macroeconomic PolicyPolicy Responses
Emerging Markets
IMF – Great Lockdown
Great Implosion?: unique speed and synchronicity
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Global Markets and Macroeconomic PolicyPolicy Responses
Emerging Markets
IMF – Great Lockdown
Great Implosion?: unique speed and synchronicity
Depressed commodity prices
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Global Markets and Macroeconomic PolicyPolicy Responses
Commodity PricesIndex, January 2, 2020 = 100
IMF
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Global Markets and Macroeconomic PolicyPolicy Responses
Emerging Markets
IMF – Great Lockdown
Great Implosion?: unique speed and synchronicity
Depressed commodity prices
Collapse in global trade
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Global Markets and Macroeconomic PolicyPolicy Responses
Global Trade, 2015-2019Index, 2015 Q1=100 and year-on-year percentage change
WTO, UNCTAD
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Global Markets and Macroeconomic PolicyPolicy Responses
World Merchandise Trade Volume2000 – 2022E, Index 2015=100
WTO
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Global Markets and Macroeconomic PolicyPolicy Responses
Emerging Markets
IMF – Great Lockdown
Great Implosion?: unique speed and synchronicity
Depressed commodity prices
Collapse in global trade
Risk aversion: sudden stop in capital flows
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Global Markets and Macroeconomic PolicyPolicy Responses
Portfolio Flows to Emerging MktsUSD billions
IIF
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Global Markets and Macroeconomic PolicyPolicy Responses
Emerging Markets
IMF – Great Lockdown
Great Implosion?: unique speed and synchronicity
Depressed commodity prices
Collapse in global trade
Risk aversion: sudden stop in capital flows
Dollar strength
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Global Markets and Macroeconomic PolicyPolicy Responses
US Dollar IndexFrom 2015, Trade Weighted, 2006=100
Federal Reserve of St. Louis
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Global Markets and Macroeconomic PolicyPolicy Responses
EM Currencies Against the Dollar Q1 2020 vs Q3 2008 , Percent change
Reuters
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Global Markets and Macroeconomic PolicyPolicy Responses
Emerging Markets
IMF – Great Lockdown
Great Implosion?: unique speed and synchronicity
Depressed commodity prices
Collapse in global trade
Risk aversion: sudden stop in capital flows
Dollar strength
Financial markets dislocation
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Global Markets and Macroeconomic PolicyPolicy Responses
MSCI EM IndexEquity Index
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Datastream, GS
Global Markets and Macroeconomic PolicyPolicy Responses
EMBI SpreadGlobal Diversified, bp
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Datastream, GS
Global Markets and Macroeconomic PolicyPolicy Responses
Emerging Markets - Issues
Reduced supply of foreign currency
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Global Markets and Macroeconomic PolicyPolicy Responses
Emerging Markets - Issues
Reduced supply of foreign currency
Weaker import cover
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Global Markets and Macroeconomic PolicyPolicy Responses
Emerging Markets - Issues
Reduced supply of foreign currency
Weaker import cover
Elevated dollar funding costs
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Global Markets and Macroeconomic PolicyPolicy Responses
EM USD Credit SpreadsIG vs HY Option-Adjusted Spread (bp)
Bloomberg, UBS
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Global Markets and Macroeconomic PolicyPolicy Responses
Emerging Markets - Issues
Reduced supply of foreign currency
Weaker import cover
Elevated dollar funding costs
Higher refinancing/default risk on FX denominated debt
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Global Markets and Macroeconomic PolicyPolicy Responses
EM FX-denominated external debtex intercompany lending, USD billions
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BIS, UBS, Haver
Global Markets and Macroeconomic PolicyPolicy Responses
EM FX-Denominated Debt as % of GDPEx-Financials and Households, Q4 2019
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IIF, National sources
Global Markets and Macroeconomic PolicyPolicy Responses
EM Debt Redemption Schedule
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IIF
Global Markets and Macroeconomic PolicyPolicy Responses
Emerging Markets - Issues
Reduced supply of foreign currency
Weaker import cover
Elevated dollar funding costs
Higher refinancing/default risk on FX denominated debt
More constraints in implementing defensive policies
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Global Markets and Macroeconomic PolicyPolicy Responses
Percentage of EM CBs Easing
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Haver, UBS
Global Markets and Macroeconomic PolicyPolicy Responses
Economic Policy ResponsesEM vs AE, Percent of Countries
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IMF
Global Markets and Macroeconomic PolicyPolicy Responses
Economic Policy ResponsesAnnounced Fiscal Measures in G20, % of GDP
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IMF
Global Markets and Macroeconomic PolicyPolicy Responses 52
WB
Global Markets and Macroeconomic PolicyPolicy Responses
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
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Global Markets and Macroeconomic PolicyPolicy Responses
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
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Global Markets and Macroeconomic PolicyPolicy Responses
HBS Global Policy Tracker
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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
Global Markets and Macroeconomic PolicyPolicy Responses
Thank you
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