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Bolder central bank policies will be pitched as the cure to economic long Covid


Cancelling debt, dual interest rates, helicopter money: if the recovery from the coronavirus crisis stalls in the developed world, we will see calls for more radical central bank action.

Vaccination programmes are under way and thank heavens for that. Many parts of the world appear unable, or at least unwilling, to find an alternative way to escape coronavirus without some form of lockdown.

Jabs hold the promise of allowing economies to reopen once more, but there are challenges. How quickly will people be vaccinated? Given that many of those who suffer badly from the virus — including those that end up in hospital — are not in the top priority groups, there is a risk in assuming restrictions will be eased too soon. And how robust will the vaccines be to new variants?

We can hope that many restrictions will be unwound over the course of the year in developed countries, bringing a post-lockdown "roaring twenties". If the economy starts purring again, central banks may finally be able to reach their inflation targets.

But let's not get ahead of ourselves. In Europe, for example, the European Central Bank only expects the Harmonised Index of Consumer Prices to rise to 1.4% by 2023. If economies remain subdued, what next?

Keen on Keynes

Many in finance have become enthusiastic Keynesians, or even Modern Monetary Theorists, in recent times; austerity is about as popular as the virus itself.

Just this week, the chief economist of the Organisation for Economic Co-operation and Development (OECD), Laurence Boone, told the Financial Times: "The first lesson is to make sure governments are not tightening in the one to two years following the trough of GDP.”

While full-throated austerity is off the agenda, the type of fiscal stimulus some would like to see looks unlikely too. In the US, Republicans will probably use every tool they can to hinder Joe Biden's spending plans. Now that corporate tax cutter Donald Trump is exiting the White House, expect the Republicans to start hand wringing about the deficit once more.

In the EU, fiscal rules have a bias towards austerity, and northern Europeans' ingrained suspicion about southerners' governance and approach to fiscal policy is unlikely to disappear completely, creating an obstacle to further shared funds. In the UK, chancellor of the exchequer Rishi Sunak's support programmes belie an underlying hawkishness. He has said his government "will always balance the books".

Low growth combined with cautious governments would leave central banks wondering what to do, when they have already yanked plenty of levers on interest rates and quantitative easing. Other ideas will come to the fore.

Rates of innovation

One is likely to be them cancelling government debt, something that has recently caught the attention of politicians in Europe. However, this faces legal and political challenges, including from the ECB itself. When the topic was broached in a European Parliament committee in November, ECB president Christine Lagarde said: "I don’t even ask myself the question. It’s as simple as that, because anything along those lines would simply be a violation of the Treaty [of the Functioning of the European Union]... I respect the Treaty, period!"

It also would not be as useful as it first appears anyway, seeing as the central bank doesn't need to cancel governments' debt to keep their borrowing costs low — as the ECB has proved.

Another more feasible idea involves using dual interest rates and giving commercial banks incentives to lend. The ECB's Targeted Longer-Term Refinancing Operations (TLTROs), which offer lenders an attractive funding rate if they lend to the real economy, would become even more important in this regard.

Such policies could be used for other policy goals. The ECB has engaged with an idea for green TLTROs, while the Bank of Japan has launched a plan to pay extra on reserves deposited by banks that become more cost efficient or that merge.

Some think central banks could radically widen the gap between the borrowing rate and the lending rate. In some ways, it is a bizarre idea; it essentially shovels money to the commercial banking sector, to let them do the work. This sounds politically contentious, but of course central banks do not answer to the electorate, and would be stepping in because elected politicians have failed to get growth going.

Then there is helicopter money, perhaps with the help of central bank digital currencies (CBDCs) — something that, in contrast, may not be so great for commercial banks.

If the developed world suffers from an economic version of long Covid, at least the central banks may have a roaring twenties of innovation.