(upbeat music)
- [Viral Acharya] Good afternoon, everyone.
Welcome back to one more session
of the Faculty Insight Series.
We are delighted to have with us from UK,
Professor Mervyn King,
as you know, Mervyn King
is a former governor
of the Bank of England,
in fact he was the governor during
the global financial crisis of 2007, 2008.
And he has then been associated with Stern
as our own professor.
So, welcome Mervyn, we are all delighted
to have you with us today.
- [Mervyn King] Well I'm very pleased to
be with you and I actually,
the strange thing about this situation
is that I actually have more contact now,
with Stern while I'm in England
than I did when things were normal,
but the advent of Zoom
is a great boom as far as I'm concerned.
- Yes, and I very much
hope that that becomes
one of the many changed habits
of our communication styles.
- I'm sure it will.
- Mervyn, since we touched upon
the global financial crisis,
why don't I use that for
the kickoff question.
And in some ways, there are
parts of what has happened,
and is likely to happen, that is similar
to the global financial crisis.
But in many ways, the pandemic
and its economic fallout
also seem strikingly different.
What do you think are the
important similarities
and the salient differences
between the global financial crisis
and the current situation in terms of
how we should be thinking about them
from an economic standpoint as well as
from the standpoint of policy responses?
- So I think there's one big similarity,
but also many important differences.
The similarity in a way, is that,
we knew that there were
things called banking crises,
and we knew there were
things called pandemics.
But that knowledge did not enable us
to predict when or where
a crisis would occur,
or indeed the nature of it.
So there were many
discussions internationally
about the unsustainability
of the position before 2007,
but no one could easily identify
precisely where you might
find a banking crisis
or when it would occur.
And I think that the conclusion from that,
is that instead of pretending
that we can attach probabilities
to these possible outcomes,
instead, we should focus on the fact that
since it is at some
point possible or likely
that these could occur,
that we focus on the resilience
and robustness of the system.
We didn't improve the
resilience of the banking system
in the run up to 2007/8, we
thought we went the other way,
we ran down the resilience of the system.
And it seems clear that although
before the COVID-19 crisis,
governments put in place
bureaucratic machinery
to cope with a pandemic,
they were less well prepared
in terms of what you
had to do on the ground.
I think the differences are,
so that's one big similarity,
I think in approaching it.
The big differences I think,
are that it in the financial crisis,
it was centered around central banks.
And that made it so much easier
to have international cooperation.
There was very close
coordination and cooperation.
Right back to August 2007,
there were phone calls
among the G7 and G10
central bank governors,
that happened all the way through.
I talked a lot to Ben Bernanke,
we organized together the
coordinated interest rate cut.
We talked a lot about the recapitalization
of the banking system.
There was a great deal of
international cooperation,
and harmonization in our approaches.
That clearly has not been true
with dealing with this epidemic.
And that's because I think that
the government people responsible,
don't naturally have the same degree
of instinctive cooperation
as central banks do.
And I think you've seen
very different responses.
Now, some of those
responses can be explained,
but my guess is that, you know,
it could be three or four years
before we're able to look back,
and understand exactly why
China handled it the way it did,
What made South Korea to handle the crisis
in the way that it did,
why Europe was different, why
the US was different again,
and why countries like New Zealand
have adopted a very different strategy,
in which they have simply said,
Well, the disease arrived in New Zealand
later than most other countries,
so we've been able to
learn something about it
before we had to take a decision.
They've enclosed completely
their international borders,
and they were able to use
a suppression strategy,
to reduce the number of
cases with such a low level,
that they can now start
to relax the lockdown
and rely just on a test
and trace strategy,
while making it absolutely
clear to their population,
that their borders will
be closed indefinitely,
for a long while, in the words
of the New Zealand Prime
Minister yesterday.
So in Europe, it's not
practical to do that.
The disease has taken hold in Europe,
there's no way that it's gonna be easy
to rely completely on closed borders.
And so I think governments
have had some big differences,
and there's also been differences
not just in policy, but in competence.
So the logistic issue are
fundamentally important here,
partly to get out the loan programs,
or the grants to businesses
that might otherwise fail,
partly to get out enough
personal protective equipment
to people on the frontline
in health services,
and partly to expand the testing programs.
And different countries have shown
different degrees of
competence in these areas,
even if there were similarities
in the high level policy decisions.
And that's a lesson as well.
I think both the US and the UK
will look back on this episode and say,
you know, we were the two
countries that on paper,
should have been the best prepared.
We had special legislation,
we had special committee
structures in government.
There were papers to bring
out of the filing cabinet
when this happened,
but what neither country
was as successful at doing,
as many countries in
Asia and some in Europe,
was actually ensuring that
what was supposed to happen on paper,
did happen on the ground.
And I think that would be a
big lesson for the future.
- Thank you, Mervyn.
You touched upon so many
interesting things there in.
In fact, I recall that one of your talks
at a Federal Reserve Board Conference
after the global financial crisis,
I distinctly remember you saying that
the best early warning
signal of a financial crisis
is that you are in the
midst of one. (laughs)
- Yes.
- It's sort of almost
impossible to predict
what's gonna be the specific shock,
and you know, that's gradually paved way
for resilience or a stress test approach,
in many ways, to all these issues.
- And I think that the medical people,
and the scientific people
had the enormous problem,
that in most epidemics,
it starts very slowly,
but then we have very few cases,
and you can't be entirely
sure how serious it is,
until it starts to accelerate,
and then it accelerates extremely quickly.
- Yeah, and let me just touch upon that
a little bit Mervyn, which is that,
I think you mentioned this point
that at the beginning of the curve,
it's sort of very hard to
know, which way is it going.
So while we have a lot
of epidemiological models
that are often being proposed,
run with various simulations
to project various curves,
it almost seems that
especially in the initial,
very sort of rapid exponential
phase, it's hard to know
what are the exact
properties of the curve.
Now, would you say that
some of the perhaps delayed,
or if I could use a stronger term,
sort of botched responses
in some of the countries
were related to this sort of model risk,
or it is perhaps a little bit also
of what recently one of
the Austrian bureaucrats
in charge of the health
policy that has reported that
smaller countries were willing
to look at other countries,
and learn from their experience
and see what best practices to adopt,
whereas some of the
bigger countries thought,
we'll deal it with our own way,
we have all this machinery and
we know how to deal with it.
- Well, it was certainly
true in the financial crisis
that when it hit the UK,
the absence of any bank
resolution mechanism,
turned out to be very serious.
And this was something which
had been pointed out before,
and I looked at all the G7 countries,
and each G7 country introduced
a resolution mechanism
for its banking system, only
after it had experienced
its own banking crisis, not one
learnt from other countries.
I think it was less true here,
I think the scientists were very willing
to cooperate with each other,
and to try and learn from each other.
But of course, once the
epidemic became serious,
everyone is working all
hours of the day and night,
there isn't time to have
relaxed conversations
with your counterparts abroad
to find out what's going on.
Though people did look
at the reported data.
But I think interestingly
one of the problems
that we've seen in Europe is often
not so much the difficulty
of constructing a model,
as politicians wanting to hand
responsibility over to
the modelers, and say,
we're just doing what the
science tells us we must do.
And science doesn't
tell us what we must do.
There are two big problems
that we've seen in this,
one is that the parameters that
drive the shape of the curve
of the number of infections
are just not known.
We didn't know enough about the virus,
we couldn't until much nearer the time.
So the lack of knowledge, I think,
has been potentially problematic.
And the second thing is that the decisions
about the strategy for
the government to follow
have to be to be taken, in the light,
not just of knowledge
about the epidemic itself,
but about the indirect consequences
of the measures taken to combat it.
And we have seen in the UK some
extraordinary developments.
For the National Health Service,
which is often alleged to be overstretched
with long waiting times for operations,
40% of the beds in the
National Health Service
are now empty because the other operations
have not been taking place.
Doctors dealing with cancer
are extremely worried
that the number of referrals
for cancer treatments' fallen by 70%.
So in the attempt to
put in place a lockdown,
what we are in danger of doing
is creating enormous costs elsewhere,
not just in terms of economic costs,
which are obviously very large,
but also in terms of the well
being and health of others.
Now, that doesn't tell us what to do,
but it means that politicians
have to take these broader judgments,
and you cannot just rely on the model.
The Imperial College Model
has has produced predictions,
which have been all over the place.
And it's not surprising,
because those models
give you very important insights
into the shape of an epidemic.
They tell you that there
is a curve to be flattened,
if you want to avoid
putting too much pressure
on health services,
but it doesn't tell you at all,
how to predict quantitatively the path
of the virus and the epidemic.
And without better information,
it's not possible to do it.
So I think this, I would
say one of the mistakes
we've made here, was
to put too much weight
on the model predictions,
which led the government
to have an abrupt change of strategy.
And now it's finding itself
in a very difficult position
because having basically
persuaded everyone
that it was too dangerous to go outdoors,
now he's trying to persuade people
that soon we're gonna
start to go outdoors,
and it'll be safe to do so.
But it's running up
against deep resistance
from trade unions and others,
who simply don't wanna take a risk.
And many of their members are
having most of their salaries
compensated by grants from the government.
So I think getting out of this
is gonna be really quite difficult.
- Thank you Mervyn, on that trend,
you know, on many different policies
that the US, UK and Europe have adopted,
there have been, of course similarities.
There is clearly a notion
of wanting to support
the livelihoods and the small businesses
and the enterprises in
one way or the other.
And yet there are important differences.
So in the United States, for example,
the reliance has been
on either giving loans,
the Paycheck Protection
Program via the banks,
approved by our Small
Business Administration
with possible forgiveness.
And of course, there are direct transfers
that are being made
depending on the income
in the household.
And on top of that, there is
some unemployment insurance.
But I think the flavor of
the United States program
is that we will let companies decide
what they want to do with
respect to their payroll,
bankruptcy filings, et cetera, et cetera,
and we'll try to contain the damage
that arises from loss of jobs and so on.
In contrast, the policies
in the UK and the Europe
seem a little bit more directly targeted,
in terms of tying the
aid to the payroll costs,
and trying to keep the jobs on
within the businesses and the enterprises.
What do you see the pros
and the cons of these,
as well as any other interesting contrasts
you want to highlight between the US,
the UK and the European responses?
- So I think at the high level,
the first response was to get cash
in the hands of businesses,
large and small,
and self employed people, in
order to prevent them from
literally running out of
money and going bankrupt.
Because if we allow this crisis
to reduce the productive
capacity of the economy,
then we'll be in serious trouble
when we start to recover and
come out of the lockdown.
The second component
was, and that first one,
to get cash in the hands of businesses,
was primarily to get loans
into the hands of businesses.
But the second one is to make sure
that many of those loans
are turned into grants.
And the reason for doing that,
is that the government has
decided, rightly or wrongly,
that to combat the virus,
it needs to have a
shutdown of the economy,
and it's basically suspended
the market economy.
If that's the case, it doesn't make sense
to allow the normal process
of deciding which businesses go bust
and which prosper to continue.
And the government I
think has a responsibility
to make transfers, and this
is not a real economic cost
in terms of resources.
This is just a transfer
to those businesses,
which have lost all takings
as a result of a government fiat.
And so I think the in Europe,
the view has been that
the government should act
as a purchaser of last resort,
not literally in terms
of going to cinemas,
going to bars, but eating
the food in restaurants,
but actually compensating
businesses for lost takings.
The easiest way to do that,
was to compensate them
for their wage bill.
To say to people look, if
you keep your staff employed,
you can follow them, send them home,
but we will pay you 80% of the wage bill.
And in that way, try to ensure
that businesses can survive,
because at some point, we want to try
and get back to normal.
And getting back to normal in this case,
I think is probably best measured
by the level of GDP as a whole.
At which point, you can then
end these transfer payments,
and then start to allow
businesses to fail,
If they find that the
demand for their products
has switched to some other kind of demand,
as a result of people changing behavior.
But until we get to that point,
I think those transfers are vital.
That pushes up the national debt,
but it's not a real
economic resource cost.
The real economic resource cost
is the consequence of a shutdown,
that is telling people they
can't go to work and produce.
They can't spend. That's
the real economic cost.
So I think we've been
quite shocked in Europe,
by the very rapid increase in unemployment
in the United States.
This is likely to have consequences,
we know from studies of unemployment
that as that persists, that
has persistent consequences,
for the well being and welfare
of those who are made unemployed.
And we are trying very hard to avoid that.
And this is not, this
downturn is totally different
From a business cycle downturn,
or from the Great Depression.
This downturn in economic output
is as a result of a
direct government decision
to tell people they cannot
work, they cannot produce.
And that should color I think,
the sort of interventions
that are appropriate.
So, ironically, if ever
there was a situation
when the government could
afford to be generous,
it's this one.
And yet, we still see
people worrying about
the costs of paying
out money to businesses
that maybe don't really deserve it.
These are all transfer payments,
we can afford to overdo it in a bit,
in order to try to get to a situation
when we can release the shutdown,
get people back to work,
and then switch off this
tap of transfer payments.
In terms of specific measures,
as I said, the employment approach
is the one that's common across Europe,
I think it's worked well.
It's easier to administer in many ways.
The one measure that I'm surprised
that governments haven't taken,
is that in the loan program,
they typically try to rely on
going by the banking system.
And that has not been straightforward,
either because the loans were not
100% guaranteed by the government.
And we had a small business program,
which had that characteristic.
So the banks were pretty reluctant
to lend a lot of money
through the program.
That's now been changed,
now we have a small business loan program
with 100% government guarantee.
A simpler, one page,
online form to fill in.
And that should help.
The difficulty of going
through the banking system,
of course, is that banks,
despite the protestations
at the outset, that they should
be allowed to pay dividends,
they weren't allowed to do so in Europe.
And that was a good thing
because the size of the
losses that will mount up
from this downturn, to bank balance sheets
are gonna be very large,
and banks will be glad
of every bit of equity capital they've got
in order to absorb those losses.
But as a result of that, knowing
that they will face losses,
this is not a situation in which banks
have the psychology to rush
out and lend to people.
We want them in this instance,
to act as agents for the government,
not to act as banks in their own right.
And that's proved difficult to organize.
Partly because I think, lack
of political willingness
to be tough enough to tell the banks
that for the time being, they're
agents of the government.
The other route that the
government could have taken,
was simply to use the tax system
to reverse the payments of tax
that had been paid last year.
If the idea was to get cash
out to people very quickly,
and many governments
postponed the payment,
in Europe of value added tax,
in some countries have
income tax payments,
but they could have gone further
and simply said not only will we defer
future payments of tax,
but we are gonna refund
to you payments of tax
that you made last year.
And that would be easy
to handle logistically,
because the Internal Revenue Service,
the tax authorities know the bank account
from which the payment was made last year,
they can just reverse the payment.
I think that would have
been something worth trying
as a means of offsetting
some of the problems,
particularly for smaller businesses,
which just don't have the machinery
to be able to easily to contact
banks and apply for a loan.
And indeed, one of the practical
problems we saw in the UK,
was that bank branches were
shut, as part of the lockdown,
so that small businesses went to a bank,
to try to ask for a loan, couldn't get in,
and the telephone lines
were completely jammed.
we just weren't, the banks couldn't easily
increase the number of telephone operators
to receive calls and deal
with bank applications.
Small businesses wanted
to go to their branch.
I thought there was a case
for keeping bank branches open
just as we kept supermarkets
and food shops open.
Anyway, all of these things,
it's easy to talk about,
but hard when you've
got the responsibility
of doing it day by day.
I think we're making
progress in these areas.
But there have been some interesting
differences between countries.
- Thank you, Mervyn.
So you refer to banks
being an important part
of the relief slash support measures,
in order to keep the productive capacity
of the economy in place.
And of course, the central banks
are also being seen as
a really important tool
in the response to the crisis.
Almost, in many cases, almost all cases
being deployed as quasi fiscal agents,
either implicitly or explicitly.
Do you see this expanded
remit of the central bank
as a necessary evil given
the situation we are in,
or as a slippery slope, because you know,
this is always something that
emerging markets for example,
have always worried about.
And if it is a necessary
evil, are there safeguards
that you think we need to put in place
to normalize the operations
in the post pandemic era?
- So I think it's
definitely a slippery slope.
And it's not obvious that central banks
are the main vehicle for
dealing with this epidemic.
Obviously central banks jumped in,
they're used to making decisions quickly,
they can expand the
money supply very quickly
through QE, but expanding the money supply
is not the most important response
to what is going on in the epidemic.
It's protecting businesses,
real businesses from failure.
And I think this is the responsibility
primarily of government.
Now, there are situations
in which central banks
can be the agent of the government,
but I think the risk is that
if central banks take actions
to purchase assets issued
by the private sector,
or by a level of government
below the federal level,
then they are taking decisions,
which as you described, are quasi fiscal.
They are decisions which
normally we think of
as being decisions that should
be taken by the government.
There is no reason why the
government couldn't create
a panel or a committee of the government,
to take those decisions,
and the central bank could
then implement those decisions
by operating at the
relevant financial markets
as the government's agent.
And that would not be going
beyond the central bank's remit.
I think the risk is that
where the central bank
is taking the decisions themselves,
that's when people will start
to say, both now and later on,
"The central bank really went a bit
"beyond its normal mandate,
these are political decisions,
"And since they were political decisions,
"and since they were necessary decisions,
"government needs to have a bigger say
"in what central banks do."
And you start to see the
independence of central banks
beginning to be eroded.
And that can happen in many ways,
it can happen through a change
in the mandate of the central bank,
it can be the government deliberately
implementing fiscal dominance.
Or it can just be the central
government decides to,
in future, appoint people
in the central bank
who will do its bidding.
And as soon as the central bank moves away
from its central task of
maintaining price stability,
which includes expanding
the money supply by QE,
provided the asset purchases,
are liabilities of the central government.
As soon as the central
bank moves away from that,
it's putting its
independence at some risk.
And I think that's not something
that central banks should do lightly.
And it's not difficult to come
up with suggested mechanisms
by which central bank
and say to government,
look, this is a decision for government,
we can implement that decision for you,
but this is our suggested machinery,
so it's quite clear that
you are taking the decision
and will be accountable for it.
Of course in my experience,
politicians are only too keen
to get central banks to do things,
for which ex post, the government can say,
well, we didn't take this decision,
you must hold the central
bank accountable for this.
But the central bank should not
let the government off the hook.
These are fiscal decisions
to be taken by governments,
even though central
banks can help sometimes
in implementing it,
although in this crisis, it seems to me
that the natural response of central banks
at the aggregate level,
isn't terribly significant at this stage.
It may be, down the road
when we're trying to get a recovery.
But central banks do not have clients
comprising thousands or
millions of small businesses,
or bigger businesses.
They deal with financial institutions.
It's the banking system that deals with
their individual clients,
it's either you go through
the banking system,
or you go through a government program,
whether it's a tax authority,
or some other program.
So I think central banks
should be cautious here,
and not feel that they are under pressure
to jump in and do something
big, just for the sake of it.
- Thank you Mervyn.
That brings me to a related question,
which is clearly large fiscal
packages are being announced,
especially in the developed economies.
With the debt to GDP
ratios, in many cases,
in some cases was already over 100%.
And it's sort of
ballooning out even further
as another 10, 15% of GDP
gets added as fiscal deficits.
You know, clearly we are
going to be looking at
extraordinarily high levels
of public indebtedness
as we come out of the pandemic.
How do you see these debts
being financed in future?
Do you think we are
likely to go down the path
that has often been adopted
in emerging markets,
which is one of financial repression,
in one way or the other,
either through taxation policy,
or financial sector regulation,
ensuring that enough savings
are getting channeled
into the public bonds.
Typically, that tends to be associated
with sort of deflationary pressures,
and at least to an extent,
also sort of low growth.
Or do you think that we
might just choose the path
of monetization, along the lines of,
you know, using the central bank
in order to help rollover
the costs of debt,
in which case you might
see a gradual build up,
perhaps an inflationary
risk down the line.
What do you think is the likely,
how is this likely to play
out in the coming future?
- So I think I'd start by saying that
I'm much more concerned
by the real resource costs
of this crisis, which is the last output,
and the impact on welfare and health
of people affected by the shutdown,
though I am by the question of how
we finance this in the longer run.
There will be a big jump in the ratio
of national debt to national income.
That's why a sensible debt strategy
has always been, that we
know that events come along
from time to time which
require such a response.
So in normal times, we
would like the ratio
of national debt and national income to be
on a gently declining path,
so that he can jump up again,
when we get one of these episodes.
After the Second World War,
the ratio of national debt
to GDP in Britain was 250%.
Way above anything that Reinhart Rogoff
would tell us was sustainable.
And I don't think there
is an arbitrary limit.
It depends on the circumstances
in which the rate of debt goes up.
I think a perfectly reasonable strategy
would be to make whatever
transfer payments
you have to make now, to
stop businesses going bust,
then to withdraw them,
then to see where you are,
then to start on this path
of the gently declining national
debt to national GDP ratio.
There's no reason why
you can't spread that
over a long period, that
requires a large increase
in tax payments.
So I think all of this is is manageable,
and should be managed in that way.
I think central banks can
help in the short term,
I think the scale of debt issuance
that's going to come,
means that it's sensible
to spread that out over
say a 12 month period.
So rather than just the government
have to issue vast amounts
of debt in one month,
spread it out, and the central
bank can help that process
by essentially if you like,
short term monetization,
I don't think that has any great risk.
And I think current circumstances,
central banks, they've engaged in QE,
to a significant extent,
there won't be any
shortage of government debt
at the federal level to buy,
in order to carry on doing more QE.
And as long as central banks
are making the decision
about how much to do,
and as long as they feel
that it's not putting at risk
their inflation objective,
then I can't see why some,
quote, monetization end
quote, couldn't take place.
But I think monetization is where,
is really where the government decides
how much money gets printed,
in order to finance their expenditure,
and in so doing risks the
future path of inflation.
As long as central banks
remain independent,
and do meet their, strive
to meet their target
of a low and steady
inflation, then it seems to me
there isn't anything particularly
serious to worry about.
So at this stage, I wouldn't panic
about the cost of the transfers.
If the government feels a shutdown
is necessary for health reasons,
then it really has to
finance those transfers
and if it means a bigger
ratio of national debt to GDP
when we get out of this, so be it.
But the real issue we should focus on,
I think it's a different one,
which is the resource
costs of the shutdown.
- Thank you Mervyn.
Let me turn to some questions
from the participants now,
we have two questions on stress points
or vulnerabilities for Europe.
One is from Philip Wolfers,
one of our MBA candidates.
He's asked a question
of what the pandemic
might cause in terms of further divisions
within the European Union,
given the current debate
over Corona bonds,
and divergent strategies with
respect to virus containment,
different initial starting points,
and perhaps, also very
different debt to GDP ratios,
as we just discussed.
- Well, it's a very important question
and a very topical one,
since this very morning,
the German Constitutional Court
has issued a ruling saying
that the ECB has three months
to come up with a good explanation
as to why its current actions
are not contrary to the European treaty,
and constitute monetary financing.
And this is not even a judgment
about the special pandemic
facility that the ECB announced,
but from its previous QE actions.
I think this is bringing the structure
of the Monetary Union into full focus
and there are two different viewpoints.
And you can understand both of them,
but they're not compatible.
One is what I call the Italian viewpoint.
They joined the Monetary
Union 21 years ago,
national income is no higher
today than it was then,
means zero growth over 21
years of disastrous outcome,
because of the consequences
of joining for them,
what was a fixed exchange rate regime,
in which they lost competitiveness,
and they're not allowed
to expand their own dept
in order to cope and
provide fiscal stimulus.
They've been hit very badly by the virus,
what's been the attitude of
their partners in Europe?
Well, some money handed
over to them, but not a lot,
and no sense in which the
Monetary Union is a single area.
And quite explicit statements,
initially by the ECB,
where they backtracked on
it, that the aim of the ECB
is not to recalibrate
bond yields across Europe.
And obviously, President Macron
has gone to great lengths,
publicly, to say this is
the moment of reckoning.
We have to have a fiscal union,
and if we don't have a fiscal union,
we can pretend that it will be easy
to keep the Monetary Union together.
That's a coherent viewpoint,
saying that the Monetary Union
must evolve into a fiscal union,
and sooner rather than later,
preferably now, in his view.
The contrary view, shared by
the German Constitutional Court
is that the Monetary Union
was a great experiment.
And the nature of that experiment was
that it would be the first monetary union,
explicitly not to go to a fiscal union.
There was a no bailout clause
in the European treaty,
which has basically been
ignored in practice,
over the last 10 years,
but it's still there.
There was a stability and growth plan.
And there was a promise
given by German politicians
to their taxpayers, and
embodied in the treaty,
which the German Constitutional
Court has to uphold,
that this would not be a fiscal union.
That's a very understandable
point of view.
German taxpayers were told
they wouldn't end up paying
for the excessive debt
levels in southern Europe,
and now they're been told that they must.
And they must ensure that spreads
between government bond
yields must be compressed.
I can't see any easy
way out of this dilemma.
You either go to a fiscal union,
or you accept that perhaps
there was a serious mistake.
And that the vision of Monetary Union
that they embarked on
was never gonna be easy,
either they have to go back to it,
and allow Italy to default
on some of its debt.
But these two visions of Monetary Union,
both of which have very good
economic and legal antecedents,
are totally incompatible with each other.
And they have been from
the very beginning,
which is why so many economists
have pointed out the fragility
of the Monetary Union.
The architecture of the Monetary Union
has not been completed, and
the phrase so often used,
but there wasn't any
architecture left to complete,
if you looked at the
original European treaty.
So I do not know how
this will be resolved.
The approach that's been adopted,
ever since the Monetary Union began,
was to kick the can down the road,
and try and find a fudge to
deal with an immediate crisis,
so a little bit of money
paid here and there,
but not such as to violate the treaty
or to change the nature
of the Monetary Union.
But of course that merely
leaves financial markets
in a state of uncertainty,
as to what would happen
if there were another
sovereign debt crisis.
So I don't think it's easy
to predict what will happen.
But what we're seeing is
more and more signs now,
that the system is coming
under serious strain,
and that the words that Mario
Draghi used back in 2012,
"We'll do whatever it
takes, within our mandate"
three little words that people forget
that he said at the end,
it's not within the mandate of the ECB
to create a fiscal union.
Even though politicians are pushing them,
from Some countries at
least, to do just that.
I think this is a very
difficult situation,
and I'm not gonna make any prediction
as to how it will be resolved.
It may simply lead us to further crises,
out of which will come
some sort of resolution.
But if they end up trying to
turn it into a fiscal union,
I think what you can see is that
that was not the end of the story,
because there would be a very
strong political reaction
against that, in Northern Europe,
which will lead to political parties,
that may see minority parties now,
perhaps becoming majority parties,
in order to reinstate the European treaty
which they believe they're governed by.
- Thank you, Mervyn.
Indeed, the fragility of
the, some of the sovereigns,
especially in the periphery
around the European debt crisis,
sovereign debt crisis in '11, '12,
was a very big stress point
for the banking sector.
In fact even for some banks
in the core countries.
There's another stress
point that's been raised
by Pedro Martinez, our
MBA student from 2006.
His question is, how vulnerable
is the banking system in Europe,
given the risk that you mentioned
of business bankruptcies
and individual job losses?
And do you see that as
a first order concern,
or do you see the future of
Europe as a first order concern
for banking sector vulnerability?
- Well, there's no doubt the
future of the Monetary Union
is a first order concern.
I think it's closely linked
to the banking system.
Maybe it's a one and a half order concern.
It certainly isn't second
order, it is very significant.
And I think the banking system in Europe
is being kept afloat by
the European Central Bank,
through extraordinary
provisions of liquidity,
borrowing against any kind of collateral
no matter how bad, and
direct subsidies essentially,
by allowing banks to borrow at lower rates
than they can deposit money with ECB.
So I'd say that the
European banking system
is certainly in a very difficult position.
And this crisis is enough to undermine
a large number of banks in Europe
without direct government support.
- Thank you Mervyn.
Turning to a slightly different tack,
we recognize that in times such as this,
monetary policy is often not
as effective as one would like,
if banks are used as the channel
for distribution of loans.
In fact, we can see this
in the United States,
where the program for small businesses
is to administer
federally guaranteed loans
via the banking system, and
there have been many bottlenecks
that have led to a somewhat
slow administration
and delivery of the loans.
An interesting question
proposed by Mayor Thomas
from the participants
is, in such a scenario,
do you think there could
have been a trustworthy role
for making transfer payments
through a digital currency,
either a digital wallet,
that the government transfers money to,
or perhaps a central
bank digital currency?
- So I think not, because I don't think
the best way of providing support
is to hand out money to individuals.
I think the better way is to try
and maintain employment here,
and prevent viable
businesses from going under
simply as a consequence of a lockdown.
Many businesses live fairly hand to mouth,
whether it's in the restaurant
sector, hospitality,
self-employed people, and if
you simply have a shutdown,
which reduces their takings to zero,
it's not long before
their payments of rent
and other contractual
payments make them insolvent.
And I think the important
thing is to protect that.
I don't think using a
digital currency is a help
from that point of view,
I think you've got to find a way
of getting money to the
hands of the businesses,
including the self-employed,
probably a very large number.
And that's why I would
have preferred a mechanism
relying more on the tax
system to pay out money.
And having collected positive tax revenue
from many of these businesses in the past,
that could have been repaid,
either as a loan or as a grant,
or as a loan with the
possibility of a grant
further down the road.
I think that would have been
a more effective mechanism.
I think it's not surprising
that it's been difficult
to get loans out through
the banking system,
because all of these
schemes have the property
that to some extent or another,
the banks either have to
share some of the loss,
or are held accountable,
or will be held accountable
for the quality of the loans they make.
And you can't expect a
machinery of a banking system
which takes its time to
decide on approving loans,
suddenly to click into emergency action.
So I think it was a mistake probably
to rely too much on the banking system,
unless you have been
prepared to take measures,
which made it quite clear to the banks,
that they were not being
asked to make loans,
they were being asked to be the vehicle
to making loans from the
government to these businesses.
And they were simply the instrument
by which this will be carried out,
a method of implementation,
and it wouldn't actually end
up on the bank balance sheet.
- Thank you Mervyn.
As we come out of the
COVID-19 outbreak, et cetera,
we've already gone through a decade
of fairly significant changes
in the financial regulation landscape.
Certainly, I think we
may not have gone as far
as we would have liked perhaps,
at least not in many parts of the world.
Nevertheless, the banking system
was much, much better
capitalized right now,
certainly in the United
States compared to 2006, 2007.
What do you think might be the big,
one or two big regulatory
changes that might get discussed?
I've heard about pandemic stress tests,
climate change stress tests,
potentially being factored in.
I've even heard extreme proposals
which don't sound as extreme anymore,
but ones where perhaps even corporations
may be required to have
a part of their debt
in the form of contingent capital,
which converts into equity,
in case there is an economic shutdown
of the type that we have just witnessed.
What do you think are one or two big ideas
that might either get revisited,
or be thrown in the mix?
- Well, this links to a theme
that John Kay and I wrote
about in our new book,
Radical Uncertainty, in which,
we actually said in the book,
which went to the publisher last year,
that we must expect to
be hit by an epidemic
of an infectious disease,
resulting from a virus
that does not yet exist.
And the reason we wrote
that, was not to show
that we were good at
predicting these things,
but to show that you can't predict them,
and you can't attach probabilities to it.
And I'm worried therefore
about thinking that the answer
is some kind of precise
quantitative response.
I just don't think we have
the information to do that.
What we learned after the financial crisis
was a very simple point, which is that
we had allowed the banking system
to be so deficient in
resilience and robustness.
But no matter how profitable
or efficient it seemed in normal time,
it could not cope with a crisis.
And that is gonna be true of every company
and every critical part of the economy.
So I'm sure that around the
world governments will say,
was our health system
resilient and robust?
We can't predict whether
another pandemic will occur,
we can't attach probabilities to it
occurring in the next five
years, we just don't know.
But what we do know, is
that if one were to occur,
we need to be more robust or resilient
than we were with this hit.
And so you have to make
a very broad judgment
as to how you're gonna improve
the resilience and robustness.
In the financial sector, we did it by
increasing capital requirements,
by trying to deal with the
liquidity position of the banks.
In the health system, it will be to have
better organized systems
for increasing quickly
the number of intensive care beds,
for bringing people back into
the health system full time,
who maybe had gone part
time or had left the system
in recent years, and stockpiling
the appropriate degree
of protective equipment,
recognizing that if there's a pandemic,
every part of the world's
gonna be affected.
You can't just go to another country
to get supplies to bring in,
everyone will be in the same boat.
And my guess is that companies too,
will say to themselves, you know,
we try to make ourselves
as efficient as possible.
We had just in time supply
chains that were cheaper
and more cost effective than
our previous supply chains,
but they were not resilient
when push came to shove.
So we need backup sources of supply.
And I think people will realize
that it's worth sacrificing
some profitability,
to invest in resilience and robustness.
But to do that in a way
that doesn't pretend
that you can come up with some precise
quantitative estimate of
what you should be doing,
because we do not have
the information available
to work out what the probabilities are
of these various events occurring.
On climate change, one
last point then I'll stop,
but much of the literature
on climate change
has been based on the idea that,
do a cost-benefit analysis,
here is a large risk.
How much of our GDP today
is it worth investing
in order to cope with the damage
that may occur down the road?
What we've learned from this,
and it's a much more general
point than just a pandemic,
is that there are several different ways,
maybe many different ways
in which the world can
come to a sticky end.
And you can't answer the question,
how much you should invest
to combat any one of these,
without taking a view about
all of them at the same time.
I mean, if you take one example,
let's suppose you came up with 10 ways
in which the world might come to an end,
of which climate change is one,
and you then say, well,
just doing a cost-benefit
on climate change, tells
you we should invest 5%
of today's GDP, in order
to combat climate change.
But the answer could be
5% for each of these 10.
But it doesn't follow that
you should therefore
invest 50% of GDP today,
to combat all these risks.
You've gotta look at all
of the risks together.
And I think you know, what will happen
as a result of this episode,
I hope is two things,
one is that people will take seriously,
the need to make our economy and our world
more resilient and robust against
risks like climate change.
But secondly, to recognize
that climate change
is not the only problem that
we should be concerned about,
and therefore we ought to look at these
potentially catastrophic
risks in one basket,
and work out what we have to do
to make ourselves resilient against them.
Because in the end, it
doesn't matter how profitable
you are, if you end up failing
to survive one of these episodes,
that's the worst of all possible outcomes.
And I think that's something
that's been ignored
in a good deal of quantitative
cost-benefit analyses.
- Let me turn to a question,
again on central banks, Mervyn.
So we saw that the Federal
Reserve especially,
was quite unprecedented in both its scale
and scope of support measures.
They had the flavor of
lender of last resort
to the market as a whole,
something that evolved
as a part of its toolkit,
especially during the response
to the global financial crisis.
Many, however did not anticipate
that the support for the junk bond markets
would actually come in
as quickly as it did.
And it has raised these
difficult questions
about were these the firms that actually
had already thrown caution to the wind
during the 12 to 18 months,
or maybe even longer before,
taken on large amounts of debt
while simultaneously making
leverage pay outs, et cetera.
And then, you know, the
sort of natural question
of moral hazard has kicked in,
which is are we really doing
this for an illiquid market,
or are we really doing this for firms
that are likely to end
up well, I don't know,
walking wounded, or living dead,
whatever is the right
zombie phrase.
Where would you think we
need to draw the line,
or where do you think, what
what's the right framework
to think about this moral hazard,
is it relevant in the present context,
and if yes, how should we approach it?
- Well, as I said before, I
don't think the right response
is for central banks to
rush in and buy assets
other than central
government debt issuance.
That's what they should be doing
in order to create liquidity
and money in the economy.
I don't see a role for central banks
in supporting particular markets,
unless there's some particular problem
in which temporarily, a market has frozen,
and there is some technical reason
why over a very short period,
central bank intervention
can help to make the market
as liquid as it was before,
then I think central banks
should stay out of it.
And I was very struck that
in the financial crisis,
whenever there was an intervention into,
say, the commercial paper market,
you only had to do a very small amount
to restore the spreads, bid-ask spread
back to a more normal level.
I fear this is the sort of crisis
where the central bank
doesn't have a central role.
And the idea of having a
monetary and fiscal stimulus
at this juncture, when the
government with one hand,
is trying to shut down the economy,
it doesn't make sense for the other hand
to try and stimulate a
monetary and fiscal stimulus.
That will come, if
necessary, down the road.
It may be necessary, I think
central banks took action
to demonstrate that they were there,
they were trying to help.
But I don't think there's
a lot they can do.
The measures that are needed to be taken
are ones for government.
So I think central banks ought
to be content in this crisis,
with more of a back seat.
And I think that's what
you've seen in recent days.
The idea that making further
cuts in interest rates
is relevant to dealing
with our current situation
strikes me as completely
strange and weird, almost.
The difficulty we're gonna have now,
is how we can find a
way out of the shutdown.
We don't know enough about the virus
to be confident as to what will happen.
And in particular, and
this is one of the things
that the models cannot
possibly model correctly,
is they do not, they cannot model
how a change of the restrictions
will lead people to change their behavior
in such a way as to alter
the degree of social distancing,
and hence this reproduction
rate of the virus.
It just, it's a behavioral thing,
past data won't tell us about
it, we will see what happens.
And so I think we're in a
trial and error mode now,
in which the governments around the world
will be lifting restrictions,
see if it doesn't lead to a
sharp increase in infections,
and then carry on relaxing a bit more.
If things turn out to be bad,
they'll reimpose the restrictions.
It's gonna be trial and error.
But I think central
banks should not really
start to intervene in
many of these markets.
The point that comes
out of this of course,
it goes back to the
previous question you posed,
which is debt finance does
not aid the resilience
and robustness of an
economy or financial system.
And too much debt, leads you
in a more vulnerable position.
And I think, somehow,
one of the consequences
of this COVID-19 episode, I think,
will be that we run the risk of seeing
very significant defaults,
or rescheduling of debt down the road,
as a means of getting to
a more robust position
with less debt in the world economy.
- Thank you Mervyn, we probably have time
for just one last question.
Let me ask you some, you know,
it's our last week of the semester here,
students are busy with their
reading periods and exams,
and of course there's a lot of uncertainty
over how the fall semester
is gonna look like.
Will students come in,
will we be able to start
classes in person, there's
very heavy enrollment
for summer classes, unfortunately,
because of the cancellations
of several internships
and job offers not leading to actual work
for many of the students.
But I think it does, you know,
the switch from in person,
to digital teaching
over the last two months,
it has raised questions
in minds of many people about the future
of higher education provision.
And how do you see this
changing in near future,
especially say for your
university like NYU,
which on the one hand had adopted
a very global network approach,
and at the same time, it's the
physical presence of students
in one of the most vibrant
cities of the world, New York,
had also been one of its big attractions.
- Well, I mean, I wish I
could be with you in person,
to debate this and discuss it
with everything opening up.
I think it's a big, big
challenge, especially for NYU,
because, as you say, I
think a wider question
coming out of this epidemic episode,
is how attractive big cities
like New York and London,
will turn out to be.
We've been in a position in which,
if you'd asked me on the first of January,
you know, where are the
two most exciting places
in the world to live?
I would without hesitation
have said New York and London.
I think that's not gonna be the answer
that people will give for a while,
and possibly a considerable while.
It will affect the housing market,
it's very striking that
one of the consequences
of the lockdown in the UK
and I suspect elsewhere,
is that the divisions
between rich and poor
have now become divisions between those
who had no choice but to stay in the city,
and those who have left to go and live
in the either suburbs or rural areas,
where it's easier to self-isolate.
So I think the attractions of New York
will certainly be diminished.
I think it will have an
effect on higher education.
I think that some of the
short-run consequences
that we must be very worried about
are the damage done to
the careers of students
who will not be able to
take exams with grades,
won't be able to get as good
an educational experience
as they deserve to have.
I think we should pay a
lot of attention to that.
Down the road, I mean,
I was very impressed
by the speed at which NYU switched
from teaching in person
to remote teaching.
I thought that was an
extraordinarily rapid transition.
And the ability of NYU
to support the software
to give guidance to
people teaching with it,
was really remarkable.
So I don't think we should
shy away from the fact
that we may, for some while,
have to carry on doing that,
and it still means it's a very
good educational experience.
But I think we will
probably in the longer run,
move to a system in which
we exploit more of this,
while going back for much of the teaching
to be in person, so that students
will have the opportunity
to come to New York again.
And my guess is that it
may take a few years,
but eventually we will
get back to the point
when once again, people will say,
I really want to be in a city
like New York, or London.
But a key part of that, I think,
has got to be a public response,
implemented by governments,
to demonstrate that
robustness and resilience
are key features of how
critical parts of the economy
are managed, either
directly by government,
or indirectly through regulation.
And that's true of the banking system,
we learned that lesson in 2008.
But it's also true of a health system,
where the US in particular,
needs to put more effort
and weight into public
health considerations,
but it's true of the UK as well.
And it's true of electricity supply,
it's true of cybersecurity,
it's gonna be true of other areas,
where we cannot afford to let
these critical systems fail.
So, I would have thought
that in the long run,
the outlook for someone studying an MBA,
or in a business school,
ought to be bright,
because there is a new course
to be taught here at NYU,
on robustness and resilience of companies.
That's gonna be critically
important in the future,
how to think about robustness
and resilience considerations,
and implement it in practice.
So that's one suggestion for a new course.
- Thank you, Mervyn.
I think it's a great idea.
We have a few courses
getting lined up in fall,
many of which have
flavors along these lines,
as you said companies are
likely to evolve their models
going forward on their own to an extent,
but perhaps also be required to do it
through government
regulations and the like.
It's been terrific to
have you with us Mervyn,
we've covered truly, a very
rich cross section of topics,
from the real economy,
to the financial sector,
banks, central banks, climate change,
and to how companies and education
might evolve going forward.
Thank you so much for your time,
I also wish to thank the
participants for coming in,
especially the students
who have chosen to be here
in spite of their exams,
and the reading week,
in the coming days.
I wish you all the best for your finals,
and I hope you and your
loved ones stay safe.
- Thank you very much Viral,
it has been my pleasure.
I'm thinking of you all at NYU every day,
and good luck to everyone
with their exams.
Thank you for inviting me.
Thank you Mervyn, thank you.
(upbeat music)
