Mar 25, 2020

Robin Brooks on COVID-19’s Impact on Emerging Markets and the Domestic Policy Response to the Crisis

The COVID-19 crisis is hitting emerging markets especially hard, and the global dollar cycle can explain why.
David Beckworth Senior Research Fellow , Robin Brooks

Hosted by David Beckworth of the Mercatus Center, Macro Musings is a new podcast which pulls back the curtain on the important macroeconomic issues of the past, present, and future.

Robin Brooks is a chief economist at the Institute of International Finance and has previously worked for Goldman Sachs and the IMF. Robin joins Macro Musings to talk about the global economic implications of the novel coronavirus. David and Robin also discuss what is happening to output gap measures, where the global dollar cycle stands today, and the importance of dollar swap lines for emerging markets

Read the full episode transcript

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to macromusings@mercatus.gmu.edu

David Beckworth: Robin, welcome to the show.

Robin Brooks: Thanks so much, David. I've heard a lot about this podcast and listened to it many times, it's great to be on.

Beckworth: Oh, thank you. Well, thanks for coming on the show. You have a very busy and important position there as a chief economist at the Institute of International Finance. I see you on Twitter a lot, I know you're engaged with clients a lot. And particularly a turbulent time like now when markets are crashing, businesses in need much of a fix. In fact, we're recording this on Monday, March 23rd, and even today there was a big news announcement that Fed added a litany of new liquidity facilities we'll talk about later, and even that didn't seem to have a big relief for the markets.

Beckworth: So there's a lot going on right now. Congress is still talking about doing something, the White House is as well. And before we get into that all that though, I want to talk about you and your work and what you do there. So walk us through what is your job, and what do you do, and what is the Institute of International Finance all about?

Brooks: Okay. Sounds good. So let me give you a very quick summary. So the IIF specializes in emerging markets, and in particular in capital flows. Although we have many other parts to the institute that do work on debt for example, that do work on ESG investing and environmental sustainable growth models. Then obviously we are a trade association that represents the global financial industry, so we have close ties to lots of the firms that are at the center of what's going on now. So we have an active dialogue with all of those, as well.

Brooks: My particular responsibility is on forecasting the global economy and forecasting capital flows. We have a track record of being relatively proactive on EM trouble spots in recent years, or difficult situations. So we try and be as forward looking as we can, though obviously markets are fickle and tricky, and often give in to overreaction. So we try and do the best we can.

Beckworth: Yeah, it sounds like you've got a very intensive job there, particularly now, and I'm wondering how does crisis affect your work? Are you working from home, are you able to go into the office? Are you able to survive at home with your laptop, or do you have a setup at home where you can look at all the data? What's it like?

Brooks: Yeah. So the big difference with the last global financial crisis, for me, is that I am seeing my kids a lot more this time around.

Beckworth: That's the upshot.

Brooks: Yeah. So I'm working from home, I'm on a laptop. I went in last week once because we did a global client call, and so I rode my bicycle because I didn't want to take the subway. So we're all adjusting to a completely different life. What I will say is maybe the umpteenth flight that I took last year, maybe it's not necessary. I've warmed to the video conferencing, so hopefully other people are having that experience as well.

Beckworth: Yeah, that will be one of the silver linings, I think. Some innovation in meetings, and how we carry ourselves, and what's really essential. Even at work. Some of those meetings may not be so important after all. Okay, well let's move to the economy, you mentioned EMs, or emerging markets, in the global economy in general. So what's the big 30,000 foot view of what the COVID-19 virus means for it?

COVID-19 and its Implications for Emerging Markets

Brooks: So let me zoom out for a second.

Beckworth: Okay.

Brooks: As you know last year we already had a recession scare, markets were focused on yield curve inversion, they were focused on what people were calling a manufacturing recession, and therefore there was already a lot of anxiety last year. The big difference to now is that in the end manufacturing is, for the big advanced economy, it's a relatively small part of total activity. So in the United States, manufacturing is about 10% of GDP. In Germany, which is more biased towards manufacturing, it's 20% of GDP. So In the end, the big economies are about services, and all the things that you and I consume day to day that are not manufactured products. Like haircuts, and the sandwich that we get a lunch, and what have you.

Brooks: So where this is fundamentally different is that COVID and this virus shock hits that services part of the economy, and it hits the consumer. So unlike the manufacturing shock last year where we, with very high confidence said, "This is not recessionary, because we have data on inventories." We knew that there an inventory overhang and that allowed us to quantify when the inventory overhang is worked down. Right now this is entirely about fear. It is about consumer's retrenching.

Brooks: And of course we have, now that we're working from home and restaurants are closed, or only doing limited business, it's very hard to consume. So we have basically the main engine in our economy which is severely curtailed at the moment. So that's the basic situation.

And of course we have, now that we're working from home and restaurants are closed, or only doing limited business, it's very hard to consume. So we have basically the main engine in our economy which is severely curtailed at the moment.

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Beckworth: Okay. So we have both a forced reduction in consumption as well as just pulling back out of fear, is that right?

Brooks: Exactly. So consumers basically are always extrapolating to the future, you and I do that all the time, too. If we feel good about tomorrow then I think at the margin we're going to spend a little bit more today. So all this boils down to us forecasting recession here in the United States in the first half of this year. I see forecasts coming out all the time from the big banks which are now forecasting jaw dropping declines in GDP in especially the second quarter. We are more middle of the road for the United States. We have growth of -2.8% for this year. I've seen estimates that are way more negative than that.

Brooks:  We have been focused on vulnerable spots in the global economy because of all of this. So the Euro is on, we have a contraction of -4.7%. So that's a big recession, that's as big as 2009.

Beckworth: Wow.

Brooks: Then emerging markets, which are typically supposed to be the growth engine, we've got big contractions in places like Mexico or South Africa. So lots of vulnerabilities.

Virus Effects on US GDP

Beckworth: So this truly is a global recession that we're about to enter if we haven't already. And I'm just curious, going back to the US, we'll go back to the EM and the rest of the world in a minute, but I'm curious about the US. You mentioned the jaw dropping numbers. So for example, I'm sure some of our listeners saw this, but Goldman Sachs came out with a -24% for the second quarter this year. And that's on an annualized basis.

Beckworth: Then Jim Bullard, the St. Louis Fed president, he really had to up that, I guess. Because he came out with a -50%. And I tweeted, "This has to be either absurd or terrifying, one of the two." So where did you come down, what were your numbers for the second quarter?

Brooks: So first of all, as you said, these are annualized numbers. So divide by four, roughly speaking. So the Goldman number is really a six percent quarter over quarter contraction, which is still basically unprecedented. We have not had a pullback as sharp as that historically. We are more modest. So we do see a contraction in the second quarter, we see a mild contraction in the first quarter, and then a drop annualized, I'll stick with the annualized format, of around 14% in the second quarter. Then critically, a recovery in the second half of the year. And I actually think it is the second half of the year that is much more interesting than the second quarter.

Brooks: The reason being, by now, we have these containment measures in place. We're at the end of March, so we have fairly good visibility on how the second quarter will look. Huge lines of business in the economy are shut down and so that will depress activity. What we don't know is what the recovery will be in Q3 and then Q4. Obviously that depends a little bit on the stimulus measures that you mentioned, but it also depends on the virus. And there is just huge unknowns.

Beckworth: Yeah. So this is unlike anything I imagine you've seen in your lifetime, is that fair?

Brooks: Completely new. And the reason that I'm emphasizing the uncertainty is A, we've got the meta-uncertainty, how long do we need containment to stay in place? I was talking to a doctor friend on Friday who was telling me, "Well, the thing about flattening the curve is that you need containment and quarantine to last a year." So that is way longer than anything I have in my forecast. And the other thing is that the global financial crisis had profound effects on how individuals in households in the United States behave. The saving rate went up following the global financial crisis basically because people decided, "I need more precautionary saving." And we could see something similar now. So the recovery in the second half of the year, depending on all these things, could be quite slow.

The saving rate went up following the global financial crisis basically because people decided, "I need more precautionary saving." And we could see something similar now. So the recovery in the second half of the year, depending on all these things, could be quite slow.

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Beckworth: Well, that's pretty sobering, the year horizon your doctor friend shared with you. My jaw dropped when President Trump at his press conference said July or August. So wow, let's hope for the best but be prepared for the worst if it comes to that. And I want to move now to the global economy and transmission mechanisms that take place. So I think it's pretty clear that what we saw first is this massive breakdown in global supply chains, and production and productive capacity. But above and beyond that this drop in demand. And one of the channels that this works through, you've been really good on this and I want you to maybe explain it to our listeners and tell us what's happened recently, is this global dollar cycle. It used to be call the global financial cycle.

Beckworth: It still is, but some people call it the global dollar cycle. That whenever the dollar begins to tighten to really has a repercussion throughout the world emerging markets. So walk us through that story and tell us where it stands today.

The Global Dollar Cycle and Where it Stands Today

Brooks: Yeah. So let me zero in on two things. So as you know, as you and your listeners know, the COVID-19 uncertainty has been building for some time. And equity markets in the United States in particular have been selling off for a while now. The straw that broke the camel's back in many respects was the OPEC meeting and the OPEC price war between Saudi Arabia and Russia, and the collapse in oil prices. That added fuel to the fire because it hurts an important sector in the United States, shale, and it exacerbates credit issues which were building because so much of the US economy was basically starting to wind down.

Brooks: So there were going to be difficulties for businesses servicing deaths and so forth. So that one important thing that exacerbated developments. The other thing that we always observe when there is uncertainty, and going back to what we were discussing before, uncertainty is very large at the moment, people head for home. They go for safe havens, and so we have seen a rush out of risky investments into safe havens, US treasuries, and maybe German bonds, and Japanese JGBs are the key safe havens globally. So when you have that, people sell risk assets, they buy safe havens, and at the end of the day emerging markets are a risk asset. They are a bet on higher growth. And when there's big uncertainty, emerging markets get sold. So that basically is what we think of as then a dollar cycle and dollar scarcity in emerging markets.

Beckworth: So are there any countries in particular that are getting hammered right now as the dollar begins to surge?

Brooks: Honestly, it is changing by the day.

Beckworth: Okay.

Brooks: So the currency that I have just been shocked by in the last week or so has been the Mexican peso. Over the past 20 days or so, the Mexican peso versus the dollar has weakened about 30%. I mean these are stunning magnitudes and scary.

Beckworth: Wow. 30%, yeah.

Brooks: 30%, unbelievable. There are many other currencies when you pull them up, so the way that currencies are quoted is number of local currency units per US dollar. So when this line goes up, it indicates that the Mexican peso, for example, is weakening. So we've seen in many, many emerging markets, this line basically go vertical. So it shoots straight up in ways that we haven't seen during the 2013 taper tantrum, or during the global financial crisis. So one of the things that's really, really scary is the speed of the selloff. It's unprecedented.

The way that currencies are quoted is number of local currency units per US dollar. So when this line goes up, it indicates that the Mexican peso, for example, is weakening. So we've seen in many, many emerging markets, this line basically go vertical. So it shoots straight up in ways that we haven't seen during the 2013 taper tantrum, or during the global financial crisis. So one of the things that's really, really scary is the speed of the selloff. It's unprecedented.

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Beckworth: Huh. And for many of these countries, I imagine it's a big, big deal because they have dollar denominated debt, so they got to pay the bill no matter what, in dollars. What if the exchange rate stays the same or they lose value like you've just described and so this is just tightening the noose around their neck. And of course if they have problems, it feeds back into us, so it's not just domestic economic problems, it's going to be a global cycle that comes back to hit us in the rear. So this is not good news, and it's a pretty terrifying thought. I mean that sharp of a drop. And when you mentioned that, it made me think of some other straight lines I've seen in the data, break evens on treasury bonds, break even inflation rate between regular treasuries and TIPS, I know there's a liquidity premium built into that. Nonetheless, it's a sign that something's really, really, you know, awful or scary for these traders that they're racing into treasuries, that break evens are falling almost straight down.

Beckworth: And now you mentioned that exchange rates, the same thing. So was it this bad in 2008? Was there a moment that was similar or do you think this is worse?

Brooks: So I think the parallel that you're drawing with 2008, 2009 is the right one, and kind of a useful device through which to look at this, what’s different, what's the same? Obviously we've got this underlying shock, which is really a virus, right? It's a medical issue. It's a public health issue, so that's completely different from '08, '09. Now it has transmogrified into credit issues in different parts of the world. The dollar scarcity in emerging markets is one manifestation of that. And so we have policy instruments like monetary policy and fiscal stimulus that can address that.

Brooks: What is a couple things that are quite different from, '08, '09. Remember in '08, '09 China did a huge infrastructure stimulus.

Beckworth: Yeah.

Brooks: And kind of rode to the rescue. So that's obviously not happening this time around. If you look at currencies that are very sensitive to what China does, for example, the Australian dollar, back in '08, '09 once the world got wind of this China stimulus, the Aussie dollar started rallying, and it was the signal really of the turn for the better for emerging markets. And that's not happening this time around. So that is a big difference from back then. China's kind of on the sidelines, I think rightly, probably the Chinese feel like they did a lot of heavy lifting during the last crisis. And so that, they can afford to sit this one out.

Beckworth: I mean, could they respond if they wanted to, do they have enough reserves, or wherewithal left, capacity to add stimulus to the global economy?

Brooks: So I think the answer to the first question, do they have reserves? Do they have capacity, Chinese reserves are still extremely high, at the peak they were north of four trillion, I think they're currently around three trillion. So that's certainly an ample cushion, but obviously lots of people worry about the leverage that was built up during the last stimulus.

Beckworth: Okay.

Brooks: And I think in the end that is making Chinese policymakers a little bit reluctant to play the same game here.

Beckworth: I see. So they're worried about having their own version of what we had in 2008, they're highly leveraged, highly indebted. So they want to be cautious. That's fair. I asked that question because it seems like, and you know more about this than I do, that China seems to be on the mend from the virus. At least it's peaked. It looks like the economy's beginning to open up again, and get its engines running. But what you're saying is they're not going to be the offset to the decline elsewhere in the global economy this time around.

Brooks: So I think you're, I like the way that you asked that question, because I think it goes to the underlying issue here, which is are we, in China's case there were dramatic containment measures that were announced, dramatic quarantines, and activity levels plummeted on all the available data that we've seen. However, we're now seeing a bounce back in some of those activity levels. And when I talk to clients most say now, "Well energy consumption is back to 70, 80% of normal, and we're seeing a trend up. So that would describe a V-shaped recovery. So a pretty quick bounce back.

Brooks: And so if that's the profile of this crisis, and that is the profile that we're forecasting for China, you've lost a couple of months of activity, but it's not the end of the world. We know how to deal with that. We can do bridge loans, and all kinds of financing to tide the economy over. If it is something more protracted, and that goes back to sort of the early part of our discussion, and if the V is a U or an L, right, there's this whole alphabet soup that people talk about, then it's more complicated.

We're seeing a trend up. So that would describe a V-shaped recovery. So a pretty quick bounce back. And so if that's the profile of this crisis, and that is the profile that we're forecasting for China, you've lost a couple of months of activity, but it's not the end of the world. We know how to deal with that.

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Beckworth: Right. Well, let's pray we have the V shape recovery. In some ways it's harder to imagine that happening because we don't have the authorities in place who can just pull people off the streets if their temperature is a little bit warm, that seems a little bit more of a reach here in the US. Although we do have the, I would think the wherewithal, the capacity to turn things around, to mobilize for mass production of ventilators and other health equipment. Where do you stand on that? Are we going to be able to turn things around quick enough both on the public health front as well as the, I don't want to call it stimulus, I'm going to call it relief package aid. Do you think between those two things we can do a V recovery or is it going to be beyond what's feasible for us?

The Possibility of a V Shaped Recession

Brooks: So you know, I think it's worth asking why are markets still so wobbly with everything that the Fed has done, and with the prospect of a pretty big fiscal stimulus coming down the pipe. Right?

Beckworth: Yeah.

Brooks: So something between one a half and two trillion now seems to be consensus. And that's big. So why is it that markets are still so wobbly? Why is the equity market down today, right? Even with everything that we've had announced and I think the reason is that at the end of the day, this is about sort of a public health issue and what markets are really good at is pricing a problem when they have data. And I think what's missing here is basically data. We don't know how widespread infections are in the United States. We don't know if we will have overrun emergency rooms a week from now. And so my number one wish is for the US to really aggressively tackle that, to do widespread aggressive testing. And I think then once we can give markets hard data on how big the problem is, they will be able to extrapolate. And frankly I think they'll calm down.

And I think what's missing here is basically data. We don't know how widespread infections are in the United States. We don't know if we will have overrun emergency rooms a week from now. And so my number one wish is for the US to really aggressively tackle that, to do widespread aggressive testing

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Beckworth: Okay, well that's an optimistic take. I like to hear that, kind of counters your doctor friend's prognosis. So let me go back the global dollar cycle before we move on, because we're moving on into other interesting areas. But I want to ask one more question on that topic, because this is a big deal, and it's easy for us in the US, and maybe even in Europe to some extent to forget the importance of this for emerging markets. And that is the role that these dollar swap lines would play in this crisis.

Beckworth: So the federal reserve has these facilities set up where other central banks in other countries can swap their currency for the dollars and that way they provide dollars to these countries that are highly dollarized, or have lots of dollar denominated debt, and the Fed has been very active. One of the things it has done is to extend that. So I have a list here of countries that have the dollar swap line and it's grown quite a bit. So I'll just quickly run off the central banks, the European Central Bank, the Swiss National Bank, the Bank of England, Bank of Canada, Bank of Japan, they had existing ones, my understanding is, and then they recently extended this, I believe on the 19th of March to the Reserve Bank of Australia, Banco de Brazil, the Danish National Bank, the Bank of Korea, Banco de Mexico, the Norwegian Bank, the Reserve Bank of New Zealand, the Monetary Authority of Singapore, and then the Riksbank in Sweden. So that's quite a growing list.

Beckworth: My question is, is that enough? Like the one big missing country on that list is China. Now, as you mentioned, China has plenty of reserves, so maybe they don't need that currency swap line, but maybe that currency swap line in China would play a calming effect, I don't know. But how important or consequential are these currency swap lines?

The Importance of Currency Swap Lines

Brooks: So the four emerging markets in the list that you read are Brazil, South Korea, Mexico and Singapore. And those happen to also be emerging markets that got Fed swap lines back in 2008, 2009.

Brooks: So in many ways there was a precedent for setting up these lines. Now from the perspective of the broader universe of emerging markets, obviously the question is what about everybody else?

Brooks: There are many other countries that I'm sure would have loved to be on that list. And I think the tricky balance is always if you announce measures for a certain group of people, then what about the rest? So I think that's a tricky balance. And I think in the end, the missing link in the puzzle is the IMF. We have international institutions, they have facilities that can be fast acting. And so if there are liquidity issues arising, then I think that's a good place for countries to draw on.

I think in the end, the missing link in the puzzle is the IMF. We have international institutions, they have facilities that can be fast acting. And so if there are liquidity issues arising, then I think that's a good place for countries to draw on.

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Brooks: The China question that you mentioned, I think I can answer in the context of our flows data. So as you know David, we do a lot of work on tracking flows and outflows and they have really been unprecedented from emerging markets during the sudden stop. The outflows have been mostly from non-China EM. So China here is very idiosyncratic. It's a case apart. I frankly don't think that they need swap lines.

Beckworth: Okay. So the world is covered between the currency swap lines the Fed has set up, and the IMF. It should be in good hands. Fair?

Brooks: Well.

Beckworth: Okay, maybe not.

Brooks: You know, I think it's all contingent on how big the underlying shock is.

Beckworth: Okay.

Brooks: I think we have uncertainty about that, right?

Beckworth: Yeah. Yeah. Okay. So, wait and see. How about that? We'll come back and maybe you have another conversation a few months from now and see.

Brooks: Cautious, cautious optimism.

Beckworth: Cautious optimism. I like that. Yeah. But, and I imagine too, some countries might be able, that don't have a currency swap line, might be able to go to a country that does, and make their own arrangements with them or through the IMF. So there should be a way to plug most of the holes, countries that aren't on that list. So we'll cross our fingers, say our prayers, and hope for the best here.

Beckworth: You mentioned oil prices already declined dramatically, just to put some numbers, they were in the 60s they fell to 20 so it's killing the US, and I'm wondering what were the Saudis and Russians thinking? And I know you can't read minds or have insights to what they were doing, but they couldn't have picked a worst time to start an oil war. And did this not dawn on them? I mean, have you thought about this, like why not work something out, come back to the table. Why now?

Brooks: Well, I can't really speak to what is going on. Obviously a structure like OPEC, a cartel is a complicated structure.

Beckworth: Yeah.

Brooks: And so you've always got issues about people going over quota and sticking to agreements. I would say that ever since 2014, the emergence of shale on the global scene has been a game changer and the oil prices have fallen from pre global financial crisis levels to levels that ever since the global financial crisis have been much lower.

Brooks: The first big oil shock that we saw other than the global financial crisis was in 2014-2015 when oil prices went from $110 to the $60 number that you mentioned and that was already a huge shock that had, in the end, a casualty was or collateral damage was emerging markets because emerging markets export a lot of commodities and so they also got hit.

Brooks: In this case, I think shale again played a big role and so I think perhaps the actions that have been taken have been motivated by that as well. What I would say, given that I think the drop in oil prices has been so destabilizing, right? I called it the straw that broke the camel's back earlier on in our conversation, this is definitely something where the G20 need to get together. This is an area for international cooperation. The drop in oil prices has been very destabilizing in an already very unsettled environment. So it's in my opinion, counterproductive.

This is definitely something where the G20 need to get together. This is an area for international cooperation. The drop in oil prices has been very destabilizing in an already very unsettled environment. So it's in my opinion, counterproductive.

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Beckworth: Yep and if anyone from those organizations or those countries are listening, please go back to the table. Okay. That may be hard to do now, now that the horse is out of the barn already in the midst of a global crisis.

Beckworth: Well, let's move back to the domestic side of the US here. As I mentioned earlier in the show, it's a big day in terms of news. In fact, there's lots of things happening. I mentioned it from your perspective. There's other things around the world happening too, but at least in my little world, I woke up this morning and this press release comes up from the Federal Reserve at 8:00 AM and it stated this is the title from the Federal Reserve. It says, *Federal Reserve Announces Extensive New Measures to Support the Economy* and extensive it was.

Beckworth: So in addition to everything that the Fed is already doing as of this date, just to recap, they've cut rates to 0%. We already have a commercial paper facility. We got money market facilities. We've got primary dealer credit facilities. We got a municipal bond market facility. We also have encouragement to come use the discount window. A lot of things that they've done already, increasing the amount of assets they're going to buy. Beckworth:           Today they unloaded both barrels of the guns, so to speak. So just to summarize some of the things they've done and we'll provide a link to their statement, but they number one, they said that their treasury purchases and their GSE purchases were going to be unlimited. They kind of said this is unlimited. We're not going to have a dollar amount but they didn't say this week. Just this week they're going to purchase 375 billion treasuries, 250 billion of mortgage backed securities and the GSEs, just this week. That's huge.

Beckworth: They're also going to buy now commercial mortgage backed securities. They're going to reintroduce the term asset back securities facility, which means in plain English they're going to start buyings and securitizing, or securitized consumer credit like credit cards, car loans, student debt, which will be helpful and directly for us.

Beckworth: Now the biggest innovations, those are all wonderful, but the biggest innovations and ones that I had to check the legality on. I had to go talk to some people about this but they're going to now start buying up corporate debt, investment grade corporate debts. They got two facilities. They've got a primary market, corporate credit facility and a secondary market corporate credit facility, I believe it's on the second one, they're even going to buy ETFs, exchange traded funds, of this investment grade corporate debt, which is a big kind of threshold. We passed a marker. We passed it. I never thought we would in my lifetime.

Beckworth: Now I checked, this is not something they can do on a permanent basis. Not yet. The Federal Reserve Act doesn't allow it but under 13(3) Emergency Conditions, they can do this temporarily.

Beckworth: Then the other big thing they're going to do is this, and they didn't give many details for it, but they mentioned a main street business lending program. So somehow they're going to go the last mile, so to speak, all the way down to households and small businesses. I imagine it's going to be done through your local bank or your credit union using the existing infrastructure. But a lot of big news items today, the Fed's really going all out and I'm wondering what is your take on this? I know you had a comment on Twitter about it, something about coordination with other central banks, but I'd love to hear kind of your assessment of what the Fed did today and how it maybe could them better or maybe did a great job, but I'd love to hear what you think.

Robin’s Evaluation of the Fed’s Extensive Response to the Crisis

Brooks: So I think the Fed deserves a huge amount of credit. It has been extremely proactive, right? I mean, I forget exactly the timeframe because it's all starting to blend into one.

Brooks: But you know, it's not that long ago that we have the policy rate at 1.6% and then we hit the emergency rate cut of 50 basis points, inter-meeting, right? That's sort of unthinkable. Then we had another inter-meeting announcement with a hundred basis points in cuts and a resumption of QE and now we have today's measures which you summarized.

Brooks: So I would say this is so forward-leaning and proactive and as I was saying before, there are issues in credit in the economy. They are a source of drag on activity, quite apart from all the other uncertainty that's going on ad so I think Jay Powell and the rest of the Fed are doing a really phenomenal job.

Brooks: My wish is for there to be a global coordination in all of this. I think it would be hugely beneficial for central banks to basically do all of this together and that in my opinion, will amplify the easing impact, the stimulus impact.

Brooks: So to give you an idea today when Fed easing was announced, when the Fed came out with its measures, the Euro strengthened versus the dollar and basically that's markets reassessing, maybe the Fed is more dovish than the ECB after all. I think that's just kind of a market discussion that we want to short circuit. I don't think this is about who's more dovish. Everybody should be easing at the same time. This is a global pandemic and so markets should be focused on that global easing dimension.

I don't think this is about who's more dovish. Everybody should be easing at the same time. This is a global pandemic and so markets should be focused on that global easing dimension.

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Beckworth: No, I agree. That makes complete sense. It's been encouraging to see the ECB make some actions and hopefully again they'll, they'll do more and get on the same page as the Fed and just work together.

Beckworth: Let me ask this question related to all the programs that we see in the United States. So we see on one hand, what we just described, a very forward-leaning Federal Reserve coming and I'm impressed, they're getting ahead of the game. I mean, compared to 2008, they were still debating, well is this inflation a concern or not? You know, a very different perspective.

Beckworth: I think everyone at the FOMC agrees something serious and bad is happening. In 2008, there was more debate and so this way the Jay Powell and the Fed can just take off to the races and be very aggressive.

Beckworth: On the other hand, you have fiscal policy. You have Congress and the Treasury and the president trying to figure out what they want to do and there's some deliberation going back and forth. But as you mentioned, they're going to put forward a pretty large bill, it includes a number of measures including direct cash transfers to households. It includes measures such as grants and loans.

Beckworth: In fact, the White House called them groans because there are loans that will turn into grants if they use them in the right way and we won't to pay them back. But measures to hopefully address every part of the economy, not just helping the financial system but also helping small and medium size businesses because if we go even a few months, some of these small businesses may never recover and you want to kind of give them a lifeline.

Beckworth: In fact the way I've been looking at this is not to call it stimulus in the ordinary sense. This is life support. We've voluntarily flipped the switch and put the US economy partly into a coma an induced coma and we're trying to now provide the life support. So it seems reasonable to me what they're doing. It's a big number. In the way again, I've tried to think about this is something unusual. It's different. Maybe even a wartime comparison might be appropriate because this is such a big shock.

Beckworth: Do you have any thoughts on just the overall picture where this is going? I mean we got big Treasury in Congress, numbers coming out. We got the Fed highly engaged. Do you see it as a cohesive whole or in need of a framework or anything along those lines?

The Overall Picture of Monetary and Fiscal Stimulus

Brooks: So I think what you said, start with the speed of these policy moves at the Fed and also in terms of what Congress is now debating is the speed is very rapid. So that's good and I think policy is proactive.

Brooks: Let me, comment on two or three things. So there's obviously the first order of question, how big should the package be? What should the size be? If you now look across some of these jaw-dropping forecasts, the 24% annualized contraction in Q2 that some people are forecasting, then depending on your forecast for the second half of the year, that can give you a drop in GDP of around five percentage points.

Brooks: So if we do a package of 2 trillion, that's about 10 percentage points of GDP and that is a good rule of thumb for how big the package should be given the drop that we're forecasting and then all the uncertainty in the second half of the year given that the virus may last longer and the shape of recovery and so forth.

Brooks: So I think these numbers are big and I think they are forward-leaning. What I would try and steer this package in terms of the direction or the nature of the stimulus, the composition, is in the end, given that this a public health crisis, the ideal way to deal with this is for the fiscal stimulus to compliment the public health emergency. So my personal issue with mailing checks, it doesn't really discourage you from going to work, say in the restaurant business or whatever, if you're feeling sick; whereas sick leave would do that. So I would love to see more complementarity of the stimulus proposals with sort of the public health dimension here. I think that would make a lot of sense.

My personal issue with mailing checks, it doesn't really discourage you from going to work, say in the restaurant business or whatever, if you're feeling sick; whereas sick leave would do that. So I would love to see more complementarity of the stimulus proposals with sort of the public health dimension here. I think that would make a lot of sense.

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Beckworth: So Robin, let me throw at you what I think should be the overarching framework and I suspect you may know where I'm going with this since you've seen me on Twitter all the time. So here's how I think about this and I agree with what you just said. This is really a two front war. It's a public health war and then there's kind of a keep the economy on life support war. There's two things going on and you need to be laser focused on both of those; completely agree. Let me focus on though the latter one, the one where we are trying to keep the economy on life support.

Beckworth: So the way I look at this as we've put the economy into a coma, it needs massive life support to keep it going and we are going to be poor. There's no doubt about this going to be harder to get certain goods. I mean simple, trivial example is toilet paper but other things are going to happen probably too. It’s going to be harder to get things that we normally take for granted, but we'll survive. We are, in real terms, going to be less affluent temporarily. That should be a given. What shouldn't be a given or what we should guard against, in my view, are the secondary spillover effects that might occur.

Beckworth: So someone who can't work, they're at home, they're told to stay home, which most of us at some point in this cycle is going to be told that. In California, that' the case right now, but we're forced to work. We're at home. Maybe we can't work at home. Maybe our job is in retail. So what happens is then you have these preexisting financial obligations like mortgages or maybe you have child support.

Beckworth: You’ve got something that you can't get out of. It's some kind of obligation that you are committed to, and I see a need to meet those preexisting obligations. And on the firm side, same thing. Maybe they have payroll obligations, they have salaries, people they've got to pay like you and me. There's obligations that emerge. And so the key to preserving those relationships, well there's two approaches here, but the one I'm going to take is you've got to keep incomes on their expected path. You've got to keep dollar incomes where you thought they would be. And collectively, so if I wrap this all up at the top, that means the overarching framework for both the fiscal and monetary policy side is to keep the dollar size of the economy intact.

Beckworth: Even though the dollars won't buy as much of new goods and services because we are going to be poor, we want to preserve the ability to pay off the existing obligations like mortgages and payroll. So what I'm pointing at, it'd be nice, let me get on my soapbox here, it'd be nice to have a nominal income target, even if it's for one year. Now of course I'd like to have one for a much longer period, but I think it'd be good to frame it in something like that. So when all these people are sitting down, all the policymakers and they have their piece of the puzzle, they see the bigger puzzle and what part they play in it. So what are your thoughts on that?

Changing to a Nominal Income Target

Brooks: I think your instinct is exactly right. I think you want to set up the economy so that once this shock is over, and I think we're all hoping it's over soon, we don't incur too much damage, so that we can all pick up and carry on where we left off. That's basically the point you're making.

Beckworth: Yup. Get that V-Shaped recovery.

Brooks: Yeah, exactly. You can give different names to that. I think the measures that are being taken are all going in that direction. I think you can also package it in a more comprehensive framework as you are. I think right now, the only downside to a more comprehensive branding is that obviously in the moment of crisis, there are lots of small fires that you've got to put out, and so maybe picking a bigger battle.

Beckworth: Right. No, you're right, right. It's hard to maybe also change horses midstream, and this horse is a particularly unwieldy one. It may not be easy, that's for sure. Absolutely. The other thing I should mention, I mentioned there's two ways and they're both really getting the same thing. One is an income perspective, maintaining dollar incomes or nominal incomes, but you could also compliment that with a mass forbearance or mass holiday of debt obligations for a few months if that's possible, but that's a massive coordination problem in itself too. None of these approaches are easy. I guess you can try to do both, complement them and there'll be people who fall through the cracks no matter what we do and no matter how ambitious we are. But I do think that's a nice way to frame it.

Beckworth: And then maintain total income size that we had going into this, but also I think to view from a war approach. We're mobilizing for a war against this virus and we want it to be done quick so we can have that V-shaped recovery. So any more thoughts from you on this? Want to move on to another topic here, but anymore?

Brooks: That's great. No, I think we-

Beckworth: Okay.

Brooks: We are in damage control mode, right? We're just trying to get through this.

Beckworth: Yep, absolutely. Absolutely. So something else that you've written a lot about and I've really enjoyed watching this, you and Adam Tooze and I forget who the other person was, but you're probably the most prominent voice out there and this is the nonsense output gap measures and it has serious implications for policy. Now, this is all maybe a little in the rear view mirror because these were things coming into this crisis, but tell us about this. What's happening to output gap measures and why does it matter?

What is Happening to Output Gap Measures and Why it Matters for Policy

Brooks: So the backdrop to this whole output gap debate, and so this is with Adam Tooze at Columbia and Philipp Heimberger, who's a professor at the University of Vienna is basically what we in the United States called a missing inflation puzzle. So we have a view on where the economy is, we have a view on what full capacity is and most international organizations and US agencies were saying before this crisis that the US economy was at or maybe even a little bit above potential GDP, so it's full employment equivalent. And if that were true, then inflation should really have been rising and perhaps it should have been higher and that really wasn't the case. And so it, in the United States, has given rise to a very active debate, which you're a part of as well on, "Well, what is potential?" Right?

Brooks: And are we at full employment? How stimulative are policies really? It goes to directly to the R-star debate on what constitutes easy monetary policy and so forth. And the only point that I've really been making is in the United States, we have this incredibly active debate, which I think is really healthy and central to policymaking and in the Euro zone where if you look at Italy GDP before this crisis in real per capita terms, GDP was almost 10% below 2007 levels. So it's been depressed for a very long time and therefore slack in the economy's likely large. But in the Eurozone we have very little in the way of debate over what is the output gap, what is slack and therefore what should the ECB be doing. And so that was really the starting point, and so the whole nonsense output gap initiative is really about that.

Beckworth: What are the implications for policy? Is it that the ECB is going to tighten too soon or are there other implications for, I don't know, IMF loans or other-

Brooks: Yep.

Beckworth: Okay.

Brooks: So the Eurozone is a monetary union without a fiscal union. So in the United States, we've obviously got lots of different states and we have a federal government and that federal government has programs that provide shock absorbers across states like unemployment insurance, right?

Brooks: In Europe, those kinds of things are still missing. There are debates on moving these things forward about, for example, paying unemployment insurance, but right now it doesn't exist. And in my opinion, this whole output gap debate is really less about monetary policy. It's about taking forward the fiscal union and ultimately creating Euro bonds, creating a European treasury that consolidates fiscal policy across the Eurozone and steers resources towards depressed areas. So Italy would be a case in point. And so for me, it's been a call to action on the fiscal policy side in Europe, that fiscal policy needs to move forward and catch up with monetary policy. And ironically, the COVID shock now and just how detrimental it's been for Italy seems like it's moving things forward.

And so for me, it's been a call to action on the fiscal policy side in Europe, that fiscal policy needs to move forward and catch up with monetary policy. And ironically, the COVID shock now and just how detrimental it's been for Italy seems like it's moving things forward.

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Brooks: Just before I got on the podcast with you, there were headlines on Bloomberg that Germany is willing to back fiscal stimulus in Italy because of COVID-19 so who knows, perhaps things are moving.

Beckworth: Wow. Yeah. I saw an article earlier, maybe the last week, that Germany is also open to Euro bonds or maybe at least discussing them, which they never would have in pre COVID-19 period.

Brooks: Yeah. So I grew up in Germany. I was born just outside of Frankfurt and I thought the Bundesbank and at the time the president of the Bundesbank, he was called Karl Otto Pöhl, they were just the coolest guys I thought. And so I certainly grew up in the German monetarist tradition and tight monetary policy is the right way to go, but that's not really what this particular issue is about. It's about completing the European project, which I think is really important. And we have an issue in Europe, we have it in many other parts of the world. We have rising populism, we have political pushback to the establishment. And I don't think that can be particularly surprising in a place like Italy where activity been depressed for so long. So let's hope that European policymakers take this seriously and use this crisis as an opportunity to do things like Euro bonds.

Beckworth: Yeah and it so happens that the ECB itself is doing a review of its policy before this shock hit so maybe part of this review will be how do we make our monetary policy more robust? Maybe we can suggest the EU chip in and contribute as well in some meaningful way on the fiscal policy front.

Brooks: Right. Right.

Beckworth: So maybe this will be an awful shock but a good one in the long run in terms of bringing about reform and changes on many fronts. And along those lines, I would like to hear briefly from you on what you think about the Fed's review. So the Federal Reserve had its own review. Started last year and it got extended this year and is supposed to go through June and maybe this shock will push that back or forward. Who knows what it will do? But what did you see of it? Is it a productive engagement? Will it lead to some meaningful change?

Thoughts on the Fed’s Review

Brooks: So go back to this missing inflation debate. A lot of the background to the review at the Fed is that we considered the 2% inflation target. You'll know this better than me, I think it was introduced in 2012?

Brooks: We think of it as a symmetric target, but we've really not exceeded 2% except for some very rare occasions if we look at core inflation or even headline core PCE. And so there is a whole debate on what is it exactly that we've put an emphasis on and should that emphasis change? Should we let bygones be bygones? Should we let past inflation misses fall by the roadside or should we do catch up? And so that's this whole debate on average inflation targeting and so forth. And given my work on output gaps, I'm highly sympathetic to that. I think it's a very important and useful debate for sure, and perhaps even a good change.

Beckworth: Yeah, and here's hoping this crisis again is a catalyst maybe to push this decision forward. It'd be great to have makeup policy. Ultimately, whatever they choose, and of course my preference as listeners know, is nominal GDP level targeting or nominal income level targeting. But all of these choices they're considering, the key feature, the common feature, is makeup policy as you mentioned, not letting bygones be bygones. And so the hope is that maybe they might make up for past misses. So we'll have to wait and see and who knows? By the time this comes out, maybe they'll have an announcement. Things are so fluid and dynamic, but maybe not. Maybe they need to hear us talk about it on the podcast to encourage them along.

Beckworth: Of course, I imagine they are incredibly busy over there. All these new facilities. The Federal Reserve has a lot on its plate. It's taken on real time payments, taken on this review, all kinds of new regulations, now has all these facilities and it's just, I imagine, a nightmare to be Jay Powell t this point, trying to do everything he's got to do. Luckily he has a good staff around him and other governors to help out.

Beckworth: Well, with that, our time is up. Our guest today has been Robin Brooks. Robin, thank you so much for coming on the show.

Brooks: It's a real, real pleasure David. Thanks so much for having me on. I look forward to seeing the podcast, listening to it and retweeting it.

Beckworth: Absolutely. Alright. Take care and stay safe out there.

Photo by Peter Zelei Images

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