Navigating the coronavirus shock: A central banker’s perspective

Dr. Stanley Fischer| Isabelle Mateos y Lago| Terrence Keeley |Apr 14, 2020

Dr. Stanley Fischer has had a highly distinguished career as a policy-maker, including as Vice Chairman of the Federal Reserve, Governor of the Bank of Israel, and Number 2 at the IMF. In these positions, he accrued experience through virtually every single financial crisis over the last 30 years – from SARS and MERS to the Global Financial Crisis, and now comes COVID-19 and some market moves unseen since 2008. With his decades of experience across the spectrum of market scenarios, Stan sat down with Terry Keeley and Isabelle Mateos y Lago to discuss how Central Banks, whether in DM or EM, in both developed and emerging markets might want to deal with the current market environment.

Capital at risk. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed.

Interview with Dr. Stanley Fischer about central banks and the coronavirus outbreak, COVID-19

As a central banker, how would you think about the impact of the coronavirus on the economy? Is it a supply shock, a demand shock or a financial shock?

SF: The impact of the virus is a combination of a supply shock and a demand shock. There has been subsequent agitation in the financial markets, but markets broadly reflect supply and demand shifts, among other economic factors. At this stage it is not clear that it qualifies as a financial shock.

So what should monetary policy agents do? Especially in countries that are not or not yet facing an epidemic at home: should they act pre-emptively, wait and see if there is an economic impact, let other actors like the government move first? Different G7 central banks have chosen different answers to these questions. Who’s right?

SF: We know that crises take longer to develop than one would expect, yet when they actually happen they are much worse than expected. Dealing with the epidemic itself is out of the hands of the central banks. Public health responsibilities reside with the National Institute of Health, the Center for Disease Control and other such institutions. But the central banks have got to do what they can, which basically is to cut interest rates.

There has been a lot of hesitation in responding to the virus’ impact. But there should not be a large lag between an event and a response. “Wait and see” is not the right way of doing stabilization policy.

In the Eurozone, given different countries use the euro, there is even more reason to act rapidly, to do what is best to support average economic conditions. Once central banks have decided on rates, banks and the private sector have greater capacity and can contribute to the improvement of the economy.

Rate cuts or increases may occur in response to any disturbance. The disturbance we are now experiencing is broadly sectorial, however. When industries are truly in trouble, like during the global financial crisis, policy aid for certain sectors or employers makes sense. Naturally there is more room for the private sector to play in dealing with these types of demand and supply shocks.

In this context, broad tools such as interest rate cuts often do not solve sectorial issues per se. Still they can help deal with the uncertainty of what the economic impact is going to be.

Assuming most DM central banks end up cutting rates in response to this pandemic, should we worry that they will become impotent, cutting rates to or below zero, and run out of tools to fight the next downturn? What happens then when the next downturn arrives? Shouldn’t CBs that ease now hurry to re-normalize if/when a V-shaped recovery arrives, like most now expect?

SF: Theoretical economic literature states, perhaps surprisingly, that the rate of interest rate adjustments should accelerate as it gets nearer to zero. However, this result precludes keeping interest rate ammunition for future disturbances.

If we knew what the renormalization was going to look like and when it would occur, we could act quickly. But it is essential that we maintain some capacity for dealing with future shocks. Having interest rates too close to zero is neither comfortable nor fair to future generations and subsequent central bankers. If the economy is still growing at a reasonable rate post-shock, rates can go back up. But it is always a matter of balance and we are never sure where the bottom is. At times, you think you have reached it – but then the economy proves you wrong.

Of course, negative rates are not impossible. In fact, I think they do what they’re supposed to do. The Swiss used them in the 1970s to keep foreign capital out. If you wanted to invest in a Swiss bank at that time, they taxed you, which is the same thing as a negative interest rate. It worked. Recently, the most extensive application of negative rates has been conducted by the Swedes and the Swiss. I used to say when I talked about this, if you’re going to try something and other people are doing it, be sure to check whether those folks are sensible or not. In the case of the Swiss and the Swedes, you couldn’t choose two more sensible peoples. Then you might think, maybe it isn’t as stupid as it sounds. It’s still hard for others to do because it is countercultural. We have been very lucky in the Fed and the Bank of England, in that we did not have to go to negative numbers.

Emerging Markets assets have been relatively resilient so far in this market turmoil. In fact, up until the latest oil shock, they have generally not had to contend with meaningful capital outflows or FX depreciation. How do you see EM central bank policies evolving?

SF: Emerging markets represent a large group of distinct economies, many of which have behaved well and kept some capacity for dealing with future shocks. It can be challenging to compare emerging market economies as they are all, to some extent, different. The oil shock shows among other things that there will be differences between what these economies should be doing.

However, it is desirable that these countries consult each other. I am not sure they would like to constitute themselves as a group comparable to the G7 to coordinate their policies just yet, but that might happen in the future. These conversations are not likely to occur as part of the G20. During a future financial crisis, I think EM countries would likely work together, but we are not there yet. However, we should not underestimate the length and importance of the current crisis; every day a new country is hit by the virus, and plunging oil prices represents challenges for some and advantages for others. The combination of oil and COVID-19 shocks could ultimately be a wide-spread crisis, which would require EM countries to start acting in a coordinated fashion.

Some EMs have seen large currency moves, including Brazil, South Africa, Chile, Russia and now Mexico. If and when such pressures do arise, do you think CBs should intervene to resist depreciation or preserve their FX reserves?

SF: I think the first instinct should be to let the market deal with it. But if the market is being very unstable and is not going where you wanted it to go, then you might well want to intervene at some point.

There was one occasion in my career, at the Bank of Israel, when we broke the rule of no intervention in the foreign exchange market. That rule had been in place for over 10 years. The Israeli economy was rather stable in the context of the global financial crisis, but foreign exchange was coming into the country in increasing amounts. The last thing you need when everyone is broke is an appreciating currency. It took some time to persuade my colleagues to intervene, and we used the critique from rating agencies stating that Israeli reserves were too small as an additional rationale to change the rule. Selling shekels for USD and EUR allowed us to raise our reserves.

The right answer depends in no small part on other currencies in your peer group. You do not want to be the only one depreciating. Fundamentals also need to be in good shape for the policy responses to deliver as intended. 

Some EM countries like Russia, South Africa and Chile often see large moves in their currency. But none of these economies are lacking sophistication on how to deal with second and third order effects. It should not be assumed that currencies in EM countries are fragile. Some EM currencies have been less volatile than some DM currencies. If you can intervene on your exchange rate and hold it at the desired level, it might even make sense to do so, even when it means temporarily having somewhat lower reserves than would be optimal. Some countries get an output advantage after depreciating successfully – so they have flexibility in the amount of reserves they should hold.

The IMF has announced that it is making available about $50 billion through its rapid-disbursing emergency financing facilities for low income and emerging market countries to help address the Coronavirus. How confident are you about the responses that are likely to result?

SF: This goes back to the delicate question of how to move a large organization in times of crisis. When running such an organization, you need to have flexibility to change your approach when required. Besides, the staff of the IMF is more than just the president, the managing director of the IMF and there is a lot of experience there of dealing with crises.

Key takeaways

  • The coronavirus is causing both a demand and a supply shock to the economy.
  • Central Banks are not the primary responders but should respond with broad-based easing measures.
  • Emerging markets may yet be more challenged than they have been so far.
  • EM Central Banks would benefit from coordinating their policy responses, notably regarding how much FX depreciation to allow. Intervention may be helpful, even if it means reserves temporarily drop below their desired long-term level.