Who are the most important economic policymakers around the world? The answer in the 2008-09 global financial crisis was simple: the leading central bankers. Ben Bernanke at the US Federal Reserve, Jean-Claude Trichet at the European Central Bank and Mervyn King at the Bank of England were top of the league. Seen as the only game in town, their actions ultimately quelled the financial storm, providing the necessary economic stimulus and co-ordinated response globally.
This time is different. While central bankers did an immensely valuable job in heading off the risk of a financial crisis in the third week of March, their subsequent actions have second division status. Health officials and finance ministers are far more important for the economy.
When it comes to supply — what can be produced in a modern economy — the influence of Anthony Fauci, the director of the US National Institute of Allergy and Infectious Diseases, Anders Tegnell, the state epidemiologist of Sweden, and Chris Whitty, the UK’s chief medical officer, has a greater bearing on our livelihoods than any central banker. Their success or failure in controlling the virus will ultimately determine the degree of mandatory or voluntary restrictions on daily lives.
To take the UK as an example, fear of the uncontrolled spread of the virus in mid-March and the compulsory lockdown later that month led to the largest drop in output for well over a century. Subsequent loosening of restrictions once the virus subsided will see a record economic bounce reported for the third quarter.
If ever there was a perfect example of the economic importance of regulations, this is it. In the months ahead, if health officials can operate a successful test and trace system to keep control of Covid-19 or distribute a working vaccine, output will continue to recover rapidly. If not, the economic situation will again deteriorate. There is no trade off between health and economics.
Central bankers would reasonably argue that apart from their regulation of the financial system, they do not claim to affect the supply side of an economy. Monetary policy affects demand. But here, a sense of scale is important. Internal simulations from the BoE’s model suggest that its March interest rate cuts might ultimately stimulate demand enough to raise the level of gross domestic product by around 1 per cent.
New research shows central banks systematically exaggerate the effect of monetary policy. But whether or not the BoE’s calculations are right, there is no doubt they are small. The UK government’s direct coronavirus support for workers, companies and households was immediate and now runs to 10 per cent of GDP.
In this crisis, there is only one area in which central bankers could claim to be crucial in supporting demand. It is in creating sufficient quantities of new money to finance wartime levels of government borrowing. But talk of monetary financing, illegal in the eurozone and a taboo elsewhere, generally brings them out in hives.
You might say, “So what? Why does it matter that central bankers no longer regulate the economic cycle as they once did?”. The problem is that politicians and the public still rely on central bankers to bring demand into line with supply, and keep inflation stable, low and positive. Central bankers pretend they are doing this job. The combination risks costly mistakes.
If governments remove fiscal support too quickly, as has probably happened in the US, or allow the virus to spread too rapidly, as appears to be happening in Europe, politicians will expect central banks to offset the damage. This time central banks cannot come to the rescue. That is likely to hurt us all.