IMFS Policy Webinars
How investors are reaching for yield in a period of large and persistent decline in real interest rates was the question Prof. John Y. Campbell addressed during his IMFS Policy Webinar on June 10. Campbell, Professor of Economics at Harvard University and renowned expert in the field of finance and macroeconomics, pointed out that this was a question also much discussed by central bankers as this situation can create incentives for investors to take on risk or to employ additional financial leverage. However, the standard finance theory does not predict reaching for yield. „Normally, risktaking depends on risk premium, risk, and risk aversion but not riskfree interest rates, „ Campbell pointed out. Looking at the approach among endowments and sovereign wealth fund, Campbell, in his joint research with Roman Sigalov, added a sustainable spending constraint to the standard model. „This implies that wealth is expected to remain constant: the investor cannot plan to run down or accumulate wealth.“ As Campbell explained, this is also applicable to individuals. „Many individuals have a reluctance to run down wealth by dissaving but are willing to take risk“. The reaching for yield gets stronger when interest rates are low“
Usually, the risky share of an investor’s portfolio depends on the reward for taking risk and on risk aversion but not on the riskfree interest rate. Campbell analyzed whether lower riskfree rate or greater impatience lead investors to want higher consumption (lower marginal utility) today relative to expected future consumption (marginal utility). In the standard model, this is achieved by dissaving.With a sustainable spending constraint, it is achieved by taking risk.This allows higher spending today, and the negative consequence, the riskier consumption, is realized in the future.
Campbell comes to the conclusion that investors take risk as a way to increase current consumption at the cost of more volatile future consumption. „The model predicts that reaching for yield gets stronger when the riskfree rate is low, and the more risk the investor is willing to take.“
- Slides (PDF)
The development of the bitcoin price is like a roller coaster ride. After reaching a new high of 60,000 US dollars in April, by the end of May the bitcoin trades at above 30,000 US dollars. Despite such fluctuations, digital currencies currently meet with high interest. In his IMFS Policy Webinar, Prof. Harald Uhlig of the University of Chicago gave an overview about current developments in this area. Since the mysterious inventor of bitcoin, Sakashi Nakamoto, has come up with the concept of a digital curreny in 2008, many more digital currencies have emerged. Ethereum, Tether, Ripple or Litecoin are just a few more names on the list of crypto currencies. Although Facebook had to trim its plans for its blockchain digitial currency Libra and moved from Switzerland to the U.S. to get regulators on board, Uhlig showed himself convinced that this trend will continue. „There will be more players to come. The technology is simple“.
Whereas the European Central Bank is still exploring the possibilities of designing a digital euro, a central bank digital currency (CBDC) has already been put into practive on the Bahamas and in the Eastern Carribean. With the CBDC, Uhlig sees the central banks in a trilemma. „Of the three central bank objectives price stability, financial stability and efficiency, central banks can only achieve two and then have to chose which.“
Summing up, Uhlig remained optimistic. In a currency landscape that is changing dramatically, central banks face competition and will have to act. On the other hand, he argued that CBDC offer central banks lots of new tools that ought to be explored. „In the last decade of negative nominal interest rates, central banks were stuck at the zero lower bound. CBDC bring new opportunities to stimulate the economy.“ Overall, Uhlig sees the technology still at an infant stage. „There are lots of technological possibilities but they’re not yet on our fingertips. It’s like when the iPad appeared.“
While the global economy as a whole is developing well and Germany has also seen a strong recovery in some areas, in view of the third wave of Corona infection, the vaccination strategy in particular is crucial for the further course of the economy. This is the current assessment of Prof. Volker Wieland. In an IMFS Policy Webinar, Wieland provided an outlook on further economic development and the challenges the German economy is facing, based on the updated economic forecast of the German Council of Economic Experts. According to the report, global trade has already returned to pre-crisis levels by the turn of the year and the manufacturing sector has recovered strongly in the United States, China and the euro area. "Demand for consumer goods and medical protective equipment were the main drivers." As a result, ocean freight costs have already risen significantly and supply bottlenecks are making themselves felt. For the United States and China, the Council of Economic Experts expects economic growth to increase by 6.3 and 8.5 percent, respectively, this year.
Currently, Wieland is already seeing effects on price development. "Inflation is back and will remain higher". According to Wieland, in addition to the base effect caused by the increase in value-added tax at the turn of the year, the rise in oil prices and food prices are also having an impact on price development.
For the German economy, the Corona restrictions create a clear dichotomy. "While manufacturing is above pre-crisis levels, consumer-related services are severely impacted. Viewing the risks of the current third wave of Corona, Wieland warns, "Production for foreign demand should be maintained at all costs." For now, Wieland believes the economy is on track. "We are running at 95 percent". The closures in retail, restaurants, events and the restrictions on travel result in a gross value added of just under five percent below pre-crisis levels. In the coming year, Wieland expects full capacity utilization to return, and for the current year, the Council of Economic Experts anticipates a plus of 3.1 percent.
The course of the third Corona wave will be decisive for further development. For its economic forecast, the German Council of Economic Experts has therefore looked closely at various simulations of vaccination progress and is betting on a significant increase in supply volumes in the second quarter. "If the general practitioners were involved, enough people could already have been vaccinated by mid-September." In comparison with countries such as Israel or even Chile, however, Germany could not score points with this. "We are not among the best internationally".
The consequences of the Corona pandemic can be seen, among other things, in insolvencies and the debt ratio. While the suspension of the obligation to file for insolvency in 2020 led to a decline in corporate bankruptcies, a significant increase is expected after the end of the exemption. In the case of the debt-to-GDP ratio, the Council of Economic Experts expects an increase from around 60 to around 70 percent in Germany this year. For countries such as Spain, an increase to around 120 percent is even to be expected. While the debt brake has been suspended this year due to the exceptional emergency situation, Wieland is confident about the coming year. "If the federal government uses its reserves, a return to the debt brake would be possible again in 2022." The good thing is that there is no need to decide now.
What is the impact of negative interest rates and which side effects do they have? This was the topic of a joint IMF-IMFS Webinar where economists and central bank watchers took stock of this experience during a discussion moderated by Prof. Volker Wieland. In a joint paper with IMF researchers, Gaston Gelos, Assistant Director and Chief of the Monetary and Macroprudential Policies Division in the Monetary and Capital Markets Department of the International Monetary Fund (IMF), finds that there is no evidence for cash hoarding. On the other hand, they observe an effective transmission to asset prices as money market rates respond almost one-to-one. In his opinion, the negative interest rate policy poses communication challenges. „There are still some lessons to learn for central banks“. He argues that central banks need to express that they will monitor potential side effects and also should highlight the difference between nominal and real interest rates. According to Gelos, further research is needed on the impact on non-banks or cross-border spillovers.
Silvana Tenreyro, Professor for Economics at the London School of Economics, argued that there was no clear evidence that negative rates have reduced bank profits overall. She pointed out that financial-market channels of monetary policy have worked effectively under negative rates and bank-lending channels have also been effective. However, „communication with the public is important“, Tenreyro said.
According to Jörg Krämer, chief economist of Commerzbank, the negative interest rate policy has only a small impact on inflation. „But over time, the negative side effects become more prominent,“ he warned. He also argued that the expansionary impact is to decline over time. „Consumers cannot bring consumption forward forever“. In his view, zombifiaction of firms is also an important aspect. Furthermore, he warned that the institutional investors‘ hunt for yields may end up in a bubble. Krämer also emphasized the importance of an exit strategy. „Before you raise interest rates, you have to put an end to Quantitative Easing“, which will be difficult for the European Central Bank (ECB), Krämer said. He also sees a risk to trigger bankruptcies. „The ECB is fully aware of that but nevertheless might be hesitant to raise rates“, he concluded.
Why the world is steering toward a rise in inflation and which global trends bring about this shift was the topic of the IMFS Webinar with Charles Goodhart and Manoj Pradhan together with Peter Praet on January 25. In their book „The Great Demographic Reversal. Ageing Societies, Waning Inequality, and an Inflation Revival“, Goodhart and Pradhan describe global trends of the future which in their opinion cause a significant rise in prices.
In the virtual discussion moderated by Volker Wieland, Peter Praet, former Chief Economist of the European Central Bank, doubted that this reversal would happen in the near future. However, he emphasized the need to prepare for such a situation although he wasn’t convinced that societies were willing to do so.
According to Goodhart and Pradhan, the rise of China, the subsequent speed up in globalization and the growing number of workers were the decisive factors of the last seventy years. During that time, the integration of China led to an increase in the working age population. This was reenforced by a higher participation of women. The combination of all these factors led to a decline in inflation. But as the British economists pointed out, „the future will be nothing like the past“.
With the so-called baby boomers beginning to retire, the work force is going to decline in many countries. While workers by definition are disinflationary, younger and older people are inflationary with the elder ones consuming a lot more than younger people, Goodhart explained. For the society as a whole, the authors consider that ageing will lead to a massive rise in deficits and borrowing. Already before the Coronavirus pandemic, they identified an upward exponential trend in the public sector debt ratio. At the same time, they predict a modest productivity – the continuation of a global phenomenon that has already been observed in advanced economies.
Although there might be mitigating factors, such as Africa and India and the technological developments, the consequence is clear. According to Goodhart and Pradhan, politicians would have to raise taxes. „This is unattractive, so there will be inflation“. In their book, they warn against this development. „Neither financial markets nor policymakers are prepared for a significant rise in inflation and wages, or a rise in nominal interest rates.“ Regarding inequality, Goodhart and Pradhan find that the world as a whole is becoming less inequal. From 2010 world inequality started declining, however, they observe that inequality has sharply increased within a country.
Praet gave credit to the authors for coming up with a competing narrative and recognized the link between the demographic factors and the inflation development in many countries. He warned that the reversal could lead to a big shock – „if it happens suddenly“. In order to prepare for this, he called for changes in the solvency law, stress tests, and asked to make financial institutions more resiliant. On the other hand, Praet did not expect an imminent change.
„In many ways, our book is a statement which trends we see and what could happen,“ Goodhart and Pradhan concluded. „The world should try to be ready when this comes true.“
Prof. Volker Wieland is confident that the German economy will return to its pre-Corona crisis level at the beginning of 2022, as he stated in the IMFS Policy Webinar on November 13, 2020: "The pandemic determines the course of the economy," said Wieland at the presentation of the annual report of the German Council of Economic Experts (GCEE), of which he has been a member since 2013. He added that although risks still existed, supply chains were intact and the sectors in lockdown only accounted for a small share of economic output. The German Council of Economic Experts expects gross domestic product to fall by 5.1 percent this year. Next year the economy could then grow again by 3.7 percent. "It is a completely different kind of crisis than the financial crisis," Wieland emphasized. Both industrial production and trade in goods had recovered much faster than after the financial crisis.
According to Wieland, both the rapid response in monetary policy and the immense fiscal aid measures such as short-time work, bridging assistance, loans and tax breaks had a supporting effect. The Pandemic Emergency Purchase Program PEPP, which the European Central Bank (ECB) announced in mid-March and increased in June, has a volume of EUR 1.35 trillion. According to the calculations of the GCEE, the German government's economic stimulus package is likely to increase economic output by 0.7 to 1.3 percent this year. So far, companies have only made use of a small proportion of the corona aid. Wieland also sees the EU reconstruction fund as an opportunity to increase competitiveness.
However, the aid measures are not always targeted, Wieland said. "A reduction of the electricity tax and an extension of the tax loss carryforward would have been more sensible than the reduction of the sales tax". Also tax increases or a property tax were the completely wrong way. "We can grow out of debt through economic growth". Because the increase in debt is less high than after the financial crisis. The GCEE expects the debt ratio to rise from 58.7 percent in 2019 to 72.1 percent this year. For 2021, the GCEE forecasts a slight decline to 71.1 percent.
In order to be able to react appropriately to future crises, however, it is necessary to reduce monetary and fiscal policy measures after the crisis, Wieland continued. "The ECB should therefore communicate an exit strategy from loose monetary policy in the coming year and show how it intends to reduce its bond holdings again".
Drastic losses in industrial production, much more severe than during the financial crisis, an unprecedented collapse in consumer confidence, declining economic output, whether in Germany, the euro zone or China. Based on current data from the Corona crisis, Prof. Volker Wieland gave an overview of the economic situation in Germany and analyzed economic policy measures at the IMFS Policy Webinar.
On the previous day, the German Council of Economic Experts, of which Wieland has been a member since 2013, had lowered its economic forecast for Germany for this year to -6.5 per cent, while it expects growth of 4.9 per cent for the coming year. For the euro zone, the Council members forecast a decline of 8.5 per cent in the current year. "Only in 2022 we can expect to reach the pre-crisis level again", said Wieland in his virtual lecture. As the development in the euro area and in the United States was worse than initially foreseeable, the economic forecast was lower than the risk scenario which the Council of Economic Experts had assumed in March when hardly any data on the effects of the coronavirus were available.
While the pandemic is now declining in Europe and the focus is shifting to other regions, real-time data point to a gradual recovery, Wieland said. Since the beginning of May, the index for truck mileage has been on the rise again and electricity consumption is also continuing to increase, after having fallen by up to 80 per cent in Italy, for example. In order to support the recovery, the Federal Government has already decided on 353 billion euros in budget-effective measures and 819 billion euros in loans and guarantees - according to Wieland about 33 per cent of the gross domestic product. Germany and Italy are therefore the countries in the euro zone with the largest fiscal support measures. However, this is not decisive for the current upward trend. "The main effect in the second quarter comes from the easing, not from the economic stimulus package", said Wieland. He therefore sees the further course of the recovery as being linked to the degree of restrictions, uncertainty and income losses.
With the emergency purchase program PEPP, the European Central Bank (ECB) has also made its contribution to the crisis. It was only at the beginning of June that the ECB decided to increase its bond purchase program by 600 billion euros to a total of 1.35 trillion euros. It was important to scale back these measures even after the crisis. "The PEPP program was not designed for the long term, so the ECB must be taken at its word", Wieland warned.
At European level, the member states could, for example, draw on the 540 billion euros package agreed in April or apply for a credit line from the ESM stability mechanism. In any case, Wieland expects a high increase in debt. It is crucial to think about the future now. "We have to see how we can grow out of the debt again and avoid a communalization of debt without control over the expenditure".
As the coronavirus shapes all economic activity and also influences monetary policy, the IMFS Policy Webinar on May 19 focused on the pandemic and the adequate policy responses.
At the online event on the date when the conference “The ECB and Its Watchers“ was originally scheduled, ECB Chief Economist Philip Lane explained the current monetary policy of the ECB, pointing out that the announcement of the PEPP program has successfully halted the tightening in financial conditions and contributed to a partial reversal in the trend. In his presentation, he made clear that the ECB was “fully prepared to further adjust our instruments if warranted“. According to Lane, this included increasing the size of the PEPP and adjusting its composition, by as much as necessary and for as long as needed.
Looking at fiscal policy, Vítor Gaspar of the International Monetary Fund illustrated the strong increase in debt due to the corona crisis. According to IMF calculations public debt will amount to 122 per cent of GDP in 17 advanced economies in 2020. In the opinion of Elga Bartsch, “for the first time, fiscal policy is in the driving seat“. In her view, the spontaneous coordination between fiscal and monetary policy is a policy revolution. On the other hand, Bartsch who is Head of Economics and Markets Research at Blackrock, warned against a blurring of boundaries which could lead to a slippery slope. “The coordination does not have clear exit strategies.” She pointed out that this could cause fiscal pressure. Francesco Giavazzi of Bocconi Unversity was also convinced that “we will emerge with lots of public and private ebt” from the coronavirus pandemic. He recommended a combination of a reduction in government spending and a reduction in taxes as policy response. In his view, the winners will be “the countries that allow reallocation to happen”.
Finally, Volker Wieland illustrated the situation in Germany. He agreed that “fiscal policy is the first line of defense”. Measures such as short-time work helped employees to remain in their companies instead of being dismissed right away. However, as economic forecasts are going deeper and deeper, according to Wieland, “the strategies of easing the lockdown is key” to economic recovery.
How the economic perspective can be helpful in the coronavirus pandemic was the topic of an IMFS Policy webinar with Prof. Harald Uhlig.
For Prof. Harald Uhlig from the University of Chicago, the implementation of a national task force of at least 50 experts from various disciplines is essential in order to face the challenges of the corona crisis. In an IMFS Policy webinar on April 17th, he explained what economics can contribute.
Uhlig warned that the current situation could even deteriorate. In view of the economic slump, a possible threat for the banking system, a threatening overload of the health system and finally the imminent destruction of society, the economic perspective could be useful in order to solve difficult allocation and distribution problems. “The competence of economics lies within data analysis and handling dynamic models,” Uhlig said. In the webinar, he gave on overview about recent research papers on the coronavirus crisis.
For example, researchers Jesús Fernandez-Villaverde and Chad Jones estimated the mortality figures in Italy at given times during the lockdown on the basis of a model often used by epidemiologists. Uhlig himself analyzed the change in behavior in an opening after a lockdown. Together with Dirk Krueger from the University of Pennsylvania and Taojun Xie from the National University of Singapore he found that there is a change in behavior of people who are afraid of getting infected. “They prefer pizza to go, enjoying it at home, or watching a soccer game on TV rather than going to the stadium”. According to Uhlig, this shift to "low-infection goods" could help to prevent an economic slump and could lead to sectoral shifts on the labor market: “The waiter of the restaurant will deliver your pizza then”.
Other scholars investigated how much politics should interfere in the corona crisis. In their calculations, economists Fernando Alvarez, David Argente, and Francesco Lippi compared the corona death toll with the extent of the economic downturn. Michael Greenstone and Visham Nigam of the University of Chicago calculated that the value of life in the United States by social distancing is worth 8.000 billion dollars. Andy Glover, Jonathan Heathcote, Dirk Krueger, and Victor Rios-Rull concentrated people's preferences . They examined the question how much lockdown people will tolerate depending on their age and job. On the other hand, Veronica Guerrieri, Guido Lorenzoni, Ludwig Straub, and Ivan Werning looked at the Keynesian supply shock.
Uhlig concluded with an urgent appeal to the federal government to make use of this diverse economic expertise pooling it together with insights from hospitals, companies and further research areas in a task force, which should be split up in respective working groups.
The slides of the webinar (PDF)
In an IMFS Policy webinar, Prof. Veronika Grimm described what a gradual easing of current restrictions in economy and society could look like.
The contact ban is still in effect, many stores are about to open but it is not clear when most of the school kids will return to their classrooms – this applies all the more to kindergarten and nursery. The restrictions in economy and society due to the coronavirus pandemic have paralyzed Germany in large parts. What a strategy for a gradual opening could look like was the topic of an IMFS Policy webinar with Veronika Grimm of Friedrich Alexander University Erlangen-Nürnberg.
First of all, flexibility is a decisive factor. “If the number of people infected gets out of control, you won’t have two or three weeks to react,” said Grimm, who is a Professor of Economic Theory and, since April, a proposed member of the German Council for Economic Experts. Together with an interdisciplinary group of fourteen scholars she has recently published a paper on a flexible and risk-adapted opening strategy.
Grimm argued that in the current lockdown various dimensions are important: the pressure on the economy, social hardships, and medical consequences. Therefore, the question when and how people can return to work can only be answered in a multidisciplinary way. For this reason, Grimm supports the implementation of task forces where researchers of various disciplines collaborate on a national and at the federal state level. These task forces are supposed to observe the impact of relaxations and regularly evaluate the situation and the appropriate reactions. In her view, a recommendation by a task force could be useful for policymakers when they have to defend their decisions. For Grimm, regionally different strategies due to different conditions based on the number of infected people and beds of intensive care available are justified. “However, rules based on certain indicators are important to minimize uncertainty,” Grimm said.
Also from a company’s perspective, clear frameworks and a certain period of preparation are necessary. “The better the preparatory measures, the more restrictions can be eased.” According to Grimm, besides the risk of infection and the question of belonging to a risk group, further decisive criteria are the importance of an area about to be opened in economy and society and the implementation possibilities of protection measures. She argued that the number of those who are infected and can pass on the coronavirus to others but do not show symptoms is also very important.
In Grimm’s opinion, digitizing the health system as fast as possible is an important instrument. In this context, she pointed out that the usual practice of using phone and fax among staff members of health authorities unnecessarily delays information processes. Also, app-based concepts for infection protection would be a significant step if they are accepted by the majority of people. A long, complete lockdown, which would also serve to avoid further waves of infection, is not conceivable at the moment. “Therefore, we will have to learn to live with protection measures for a long time and we will have to learn more about the coronavirus as fast as possible,” Grimm concluded.
In an IMFS Policy webinar, Prof. Volker Wieland presented the economic outlook of the German Council of Economic Experts in the coronavirus pandemic.
In view of the coronavirus pandemic the German economy is heading towards a bigger recession in the second quarter than during the financial crisis in 2009. In an IMFS Policy Webinar on April 8, he presented the scenarios of the German Council of Economic Experts‘ special report. According to the report, a shutdown of five weeks and a recovery of three weeks would be manageable. However, “at the moment it does not look like this is going to happen,” Wieland warned. In comparison to the end of March – the publication date of the special report – the probability for a risk scenario with a pronounced V has increased.
The coronavirus pandemics at the same time hurts supply and demand. On the supply-side of the economy, the supply chains were disrupted and industrial inputs for chemical products or in the engineering industries could not be delivered. On the other hand, the demand for services in tourism, for events or in the catering sector were reduced due to quarantine measures. Therefore, according to Wieland, a conventional stimulus package is not helpful. “It is not a matter of stimulating demand but of maintaining capacities by offering credits or liquidity.” In his view, a capital levy would also be the wrong measure, hurting mostly medium-sized companies. “This would counteract all rescue packages,” Wieland warned. Instead, he called for discussing an exit strategy ugently. “We have to establish rules for our health as a basis for ramping up production again.” He argued that a task force made up of experts of various disciplines could help in this process.
Wieland rejected so-called corona bonds, mutualized debt without any influence on the spending. This could lead to hard disputes between the member states, Wieland warned. He rather recommended the European Stability Mechanism (ESM). Regarding the stigma states such as Italy were afraid of, he recommended several states to make use of a credit line with the ESM simultaneously. In Wieland’s opinion, the interventions of the Euorpean Central Bank (ECB) that announced the Pandemic Emergency Purchase Programme (PEPP) on March 18 are only a temporary support. The ECB has delivered in advance and can only reduce the spreads of various countries during a certain time, Wieland argued.
Presentation (in German) "Die gesamtwirtschaftliche Lage angesichts der Corona-Pandemie" (PDF)