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Kicking off the weekend, let me share a few thoughts on the two-edged sword of the sovereign-bank-corporate nexus.
Yesterday, @Isabel_Schnabel gave a speech at an LSE-panel on the old and new linkages between sovs, firms & banks in the pandemic:
https://www.ecb.europa.eu/press/key/date/2021/html/ecb.sp210128~8f5dc86601.en.html 1/10
Yesterday, @Isabel_Schnabel gave a speech at an LSE-panel on the old and new linkages between sovs, firms & banks in the pandemic:
https://www.ecb.europa.eu/press/key/date/2021/html/ecb.sp210128~8f5dc86601.en.html 1/10
In the speech she outlines how fiscal and monetary policy support in the pandemic created a “virtuous” feedback loop between sovereigns, banks and corporates which prevented an even worse economic fallout. 2/10
Through guarantees and transfers, fiscal authorities shielded firms from cash flow shortages and – supported by monetary and supervisory policy – ensured that firms can weather the storm by accessing credit at favorable rates (at least partially). 3/10
That virtuous cycle could however turn “vicious”, potentially amplifying negative shocks in any of the 3 sectors due to the increased interlinkages (see speech for more details). 4/10
I had three thoughts on this: First – regarding the impact of guarantees on government finances – it seems possible that governments may actually *reduce* their risk exposure by assuming corporate credit risk through guarantees. Why? 5/10
By supporting firms’ financing conditions, the guarantees have a positive macro impact which in turn reduces the likelihood of these additional contingent liabilities from materializing. This “pulling-yourself-up-at-the-bootstraps” argument is not new, but has been made 6/10
before, e.g. in this paper in the context of central bank risk mgmt and asset purchases:
https://www.sciencedirect.com/science/article/pii/S0304393219302016?via%3Dihub
Second, the virtuous-vs-vicious cycle argument reminds me of the fiscal-multiplier discussion which found that fiscal multipliers tend to be larger in downturns. 7/10
https://www.sciencedirect.com/science/article/pii/S0304393219302016?via%3Dihub
Second, the virtuous-vs-vicious cycle argument reminds me of the fiscal-multiplier discussion which found that fiscal multipliers tend to be larger in downturns. 7/10
My hunch is that the increased interlinkages between sovereigns/firms/banks may imply an even larger fiscal multiplier than in previous recessions. Unfortunately, multipliers work in both directions which is why a premature withdrawal of policy support 8/10
may be particularly problematic in the current situation.
Third, guarantees are a bit special in that context because they don’t constitute an immediate fiscal expenditure but might even stabilize the macroeconomy without the government ever spending a single euro. 9/10
Third, guarantees are a bit special in that context because they don’t constitute an immediate fiscal expenditure but might even stabilize the macroeconomy without the government ever spending a single euro. 9/10
What’s then the fiscal multiplier of guarantees? Potentially infinity? I don’t know. But certainly it’s worth thinking about what the extended use of gov. guarantees means for aggregate estimates of fiscal multipliers and the optimal fiscal policy mix. 10/10
