Much has rightly been said about the uniqueness of this crisis. The crisis has resulted from a policy to tackle a health emergency through containment measures. Hence characterisations such as “putting the global economy into an induced coma” or “into hibernation”. And it has induced contractions in output and employment that have been even steeper than those during the Great Depression. Hence characterisations such as “a global sudden stop” (Fig. 1).
All this means that, in contrast to the Great Financial Crisis (GFC) of 2007–2009, the present crisis has three key features. It is truly exogenous, not the result of the unravelling of previous financial imbalances—the typical recession trigger since the mid-1980s. It is truly uncertain, in the specific sense that the wide range of possibilities depends on unpredictable non-economic factors. And it is truly global: despite how the 2007–2009 crisis is generally portrayed, many countries did not actually experience it, not least in Asia.
A unique crisis calls for a unique response. The response has been unique in terms of objectives: not so much to boost aggregate demand so as to elicit increases in supply—home confinement has made the two highly unresponsive to traditional macroeconomic stimulus—but to offer a lifeline to firms and households during lockdowns, by providing the necessary bridge financing and resources. It has been unique in terms of scope: there has been unprecedented coordination between monetary, fiscal and prudential policies. And it has been unique in terms of the characteristics of the response in each of the policy areas.
Take monetary, prudential and fiscal policy in turn.
Monetary policy has relied less on interest rate cuts than on its time-honoured lender of last resort function. To be sure, cuts have been implemented; but more to instil confidence than to boost demand through the usual channels. For its part, the lender of last resort function has hardly followed standard script, as it has been adapted to the nature of the shock and the evolving structure of the financial system.
This adaptation deserves particular attention.
In one respect, speed and scope aside (Table 1), the adaptation has simply extended the evolution already seen during the GFC because of the rapid growth of market-based finance relative to bank finance (Fig. 2). Central banks have acted more as dealers or, strictly speaking, buyers of last resort than just lenders of last resort. Hence, their large-scale purchases of both private and public sector securities in an effort to stabilise markets. Indeed, for the first time, central banks in emerging market economies (EMEs) have done the same, by intervening in their now better developed domestic currency bond markets, where foreign investor participation has greatly increased (Arslan et al. 2020). This is testimony to EMEs’ much stronger and more credible macroeconomic frameworks, which have also allowed central banks to cut, rather than raise, policy rates.
In another respect, monetary policy has broken new ground. Central banks have gone one step further relative to the past, seeking to cover “the last mile” to reach businesses directly, including small and medium-sized enterprises. They have done this through backstops for bank funding. For example, think of the Fed’s Main Street Lending Program and its direct purchases of corporate securities. In the process, central banks have gone down the credit scale more than ever before, including taking on risk below investment grade (or the equivalent when companies are unrated).
Prudential policy has taken an unprecedented direction (Borio 2020; Borio and Restoy 2020). Rather than encouraging banks to shore up their balance sheets and retrench, it has actually encouraged them to partly draw down the capital buffers accumulated since the GFC in order to keep credit flowing. By “capital buffer”, I mean the amount of capital above regulatory minima. To that effect, prudential authorities around the world have used the available flexibility to: ease both capital and liquidity requirements; impose blanket distribution restrictions, such as on dividends; and ease both the classification of exposures, such as non-performing loans, and the regulatory treatment of accounting losses—specifically, the new expected credit loss provisioning standard (Fig. 3).
This fundamental change in approach reflects three factors. The first is the sense that everyone had to play their part to tackle the emergency. The second is the post-GFC change in perspective from a purely microprudential (MiP) approach—focused on the safety of individual banks considered in isolation—to a more macroprudential (MaP) approach, which considers them as part of a system (Borio 2018). Hence the notion of the “fallacy of composition”: it may be rational and indeed compelling for each institution to retrench and cut lending as the outlook deteriorates. But, if all do so collectively, they may actually end up worse off because of the spillbacks from the real economy. This is an instance of the excessive procyclicality of the financial system. Finally, the unique response reflects the fact that the banking system was much better capitalised going into the crisis, largely thanks to the post-GFC financial reforms (Fig. 4). As a result, policymakers could look upon banks as part of the solution, rather than as part of the problem.
In its own way, fiscal policy, too, has broken new ground. Huge size aside (Fig. 5), it has responded with a speed that is in all likelihood unprecedented. And it has adjusted the response to the nature of the shock. Hence the heavy reliance on furlough schemes designed to keep employees attached to their firms, and on guarantees extended either to borrowers, thereby providing banks with essential incentives to keep lending, or to the central bank, thereby leveraging its firing power.
So far, the concerted policy response seems to have worked. Financial markets have stabilised—if anything, “too much”, in the sense that risky asset prices appear to have run ahead of a realistic assessment of the economic outlook (Fig. 6). Credit has kept flowing: bank credit has increased, while it had contracted during the GFC (Fig. 7). In part, this reflects the fact that, as firms drew on their credit lines, banks did not cut other forms of lending, at least to the same extent, and the economy has withstood the shock. Granted, the drop in activity has been dramatic. But activity has begun to rebound since the easing of containment measures (Fig. 1), and the drop would surely have been much bigger without such a vigorous policy response.
Still, near-term and longer-term challenges remain, and they crucially depend on the uncertain evolution of the pandemic.