Central banks must address pandemic challenges

This article first appeared in Forum, The Edge Malaysia Weekly, on August 9, 2021 - August 15, 2021.
Central banks must address pandemic challenges
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Hopes for an inclusive global economic recovery are fast fading. As rich countries have done little to ensure poor countries’ access to vaccines and fiscal resources, the North-South fault lines will certainly widen.

While the International Monetary Fund (IMF) has revised rich countries’ recovery prospects upwards, the UN notes formidable challenges, especially for developing countries, owing to the pandemic.

The UN warns of more setbacks for the Sustainable Development Goals (SDGs), already behind schedule before the pandemic. Grim recovery prospects have been worsened by debt distress and dramatic drops in investment and trade.

Designing appropriate relief, recovery and reforms well is necessary. For the IMF, growth-enhancing reforms could significantly improve growth in emerging markets and developing economies over the next decade.

Countries must quickly spend much more to contain the pandemic and offset the adverse effects of policy responses. This is needed to protect incomes, jobs and businesses, while paying more attention to the most vulnerable. Also, the SDGs still need more financing.

Policy choices now will determine chances of a greener, more inclusive and resilient future. There must be better synergies among short-, medium- and long-term policies through improved coordination.

Macroeconomic policy coordination

Although public debt is already high while tax revenue has shrunk, governments need to spend more. Central banks (CBs) must lend more to governments to create more fiscal space. Better monetary policy support for government spending should strengthen relief, recovery and reform, not enable more corporate debt and asset price bubbles.

In turn, fiscal authorities can create monetary policy space by enabling spending on nationally produced goods and services, investing in productive capabilities, enabling new jobs and occupations, and expanding social protection. Policy design should ensure that more liquidity does not generate excessive inflationary pressures or net imports.

Greater CB independence in recent decades has undermined macroeconomic policy coordination, preventing CBs from lending directly to governments. Keeping inflation low has become paramount, ignoring other policy goals. Supposedly for CB and monetary policy credibility, such priorities actually serve financial investors, especially speculators.

But with unconventional monetary policies after the 2008 global financial crisis, CB lending to governments has become more acceptable. Many rich governments have since turned to CBs for fiscal space and other finance.

With little affordable finance available from both private and official sources, some developing countries, such as Indonesia, have temporarily suspended laws preventing direct borrowing from CBs. Others like the Philippines have amended legislation to allow CBs to directly lend to governments.

Thus, how countries emerge from recessions in the short term, and transform their economies to achieve progress in the longer term, critically depends on effective cooperation between CBs and governments.

Central banks’ developmental role

Historically, CBs have played a developmental role, for example, financing public investment. Even though many CB statutes are not explicit about such roles, the two oldest CBs — the Bank of England and Sweden’s Riksbank — are not prohibited from vigorously promoting policy priorities, for instance, the latter’s commitment to housing for all.

The Bank of England has even pioneered creating specialised development institutions, like the Industrial and Commercial Finance Corporation, the Finance Corporation for Industry and the Bankers’ Industrial Development Company.

The US Federal Reserve Act, on the other hand, is committed to realising “the economy’s long-run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates … in furtherance of the purposes of the Full Employment and Balanced Growth Act of 1948”.

The CBs of Italy, Germany, Japan and the Netherlands have used various means to finance activities underserved by credit markets. These include lowering bank reserve requirements and lending for priorities such as housing, agriculture, exports, small business and underdeveloped regions.

Well before independence, the Reserve Bank of India observed that “it may be desirable for Central Bank credit to be made available in a larger number of ways and with less restrictions”. Hence, development objectives are explicit in many developing countries’ CB statutes.

The statutes of some CBs established in the 1970s and 1980s with IMF technical assistance also have specific provisions for developmental roles, for example in Bhutan, Botswana, Fiji, Maldives, Solomon Islands, Swaziland and Vanuatu.

This is consistent with IMF Article of Agreement IV, which states that “each member shall endeavour to direct its economic and financial policies toward the objective of fostering orderly economic growth with reasonable price stability, with due regard to its circumstances”.

The Bangladesh CB, a financial inclusion pioneer, also adopted a sustainable finance policy in 2011 to promote green investment and sustainable agriculture. Ninety developing country CBs have since signed the Maya Declaration — a global initiative for responsible and sustainable financial inclusion that aims to reduce poverty and ensure financial stability for the benefit of all — to advance financial inclusion.

Supporting transformation

Borrowing to finance recovery and reform has to promote desirable changes, creating new productive capacities, accelerating digitalisation, revitalising rural and regional economies, conducting business and work in new ways and making economies more sustainable.

The European Central Bank (ECB) has aligned quantitative easing with the European Commission’s (EC) pandemic response. By indicating it would buy newly issued government bonds in the secondary market, the ECB has effectively financed government borrowing despite the ban on directly lending to the government.

Thus, considerable ECB purchase of government bonds has lowered borrowing costs for member states’ pandemic responses. These include the EC’s Next Generation package, which covers the European Green Deal and its “digitalisation transition”.

The Bank of Japan is supporting government efforts for relief, recovery, economic growth, structural change, disaster management and global warming mitigation. It is also encouraging companies to invest in digitalisation and green technologies.

The South Korean CB has purchased more government bonds. Several measures have provided monetary support for the “Korean New Deal”, including pandemic relief, recovery, digital and green investments and employment safety nets.

China’s CB’s targeted monetary policy tools are increasingly aligned with the government’s long-term strategic goals. These include supporting key sectors while preventing asset price bubbles and overheating.

Bolder actions needed

Over the last year, poorer countries have been condemned to protracted recessions and delayed recoveries. Vaccine imperialism and apartheid mean that their vaccination efforts will be delayed and limited, if not worse.

Extended slowdowns not only threaten to become depressions, but also to further set back the modest progress achieved in recent decades. The North-South gap between rich and poor countries is certain to grow again.

Recovery prospects have been set back by poor countries’ lack of fiscal space. The IMF must help them use monetary policy much more creatively, not only to enhance fiscal space, but also to complement other policies for relief, recovery and transformation.


Anis Chowdhury, a former professor of economics at the University of Western Sydney, held senior UN positions from 2008 to 2015 in New York and Bangkok. Jomo Kwame Sundaram, a former economics professor, was UN assistant secretary-general for economic development. He is the recipient of the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought.

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