Just like old times: quantitative easing has fundamentally changed the role of central banks everywhere © Oli Scarff/Getty Images

Saved by the bankers

During the pandemic central banks averted a financial collapse, but they can't admit how they did it
September 1, 2021

Adam Tooze was once best known as a leading economic historian of the 20th century. The Wages of Destruction (2007) represented a major challenge to the conventional understanding of the Nazi war economy, while 2015’s The Deluge re-examined economic changes in the 1920s. Crashed, published in 2018, was his first book of contemporary economic history, covering the financial crisis and its aftermath. Shutdown, his new book, represents another shift, and transforms Tooze from being principally an economic historian to an analyst of contemporary global capitalism. If this is history, it is instant history, assembled not from archives but from journalism, podcasts and Twitter. Such works always run the risk of being a mere collage of snippets and facts. Shutdown, thankfully, avoids that trap. What sets it apart is Tooze’s ability to keep his eye on the big picture—and the long view.

The genius of Crashed was to elucidate the intimate, but previously buried, connections between the banking crisis of 2008 and the Eurozone crisis of 2012-2015. Shutdown is equally illuminating on the events of March 2020—the month when the pandemic triggered a truly global economic crisis. Lockdowns caused a freefall in economic activity, with some of the steepest monthly declines in GDP ever recorded. But unlike in 2008 there is another very different story—that of a financial (as opposed to economic) crisis averted. Importantly, this is not just a story of the west: most emerging market economies were also spared a serious financial crunch. The question is: how was it done?

The answer lies (partly at least) in the nature of modern central banking. One of the most confusing aspects of the last 15 years has been the shifting role of central banks. The model of independent central banks, generally targeting a certain level of inflation, grew out of the traumatic experiences of the 1970s and 1980s. In the 1990s, the norm was for an independent central bank to manage the business cycle using interest rates to target a desired level of inflation. Fiscal policy, which dominated arguments about policy from the 1940s to the 1970s, took a back seat. Politicians, in effect, stepped away from the problem and handed the reins over to the technocrats.

Underpinning this shift was the notion of “credibility.” Finance ministers, it was feared, could never be trusted because they would be tempted to overstimulate an economy before elections. Indeed, economists wrote papers on “deficit bias,” explaining how the interplay of political choices and elections could condemn even countries with intelligent citizens and honest rulers to imprudence. The great fear was of loose fiscal policy and rising inflation becoming politically impossible to grip.

Technocrats, by contrast, would have more credibility when it came to controlling inflation, and that credibility was an economic virtue in its own right. Because if investors, firms, workers and unions haggling over wages all believed that an independent central bank would choke off inflation early, they would invest, employ, price and bargain in ways consistent with that. Consequently, policy would not have to be tightened so much. The expectation of firmly “anchored” inflation would thus become self-fulfilling.

Crucial to maintaining this all-important credibility was said to be a separation between monetary policy and fiscal policy in general, and government debt management in particular. It hardly mattered that managing government debt had historically been a core purpose of central banks. In an era when central banks were supposedly single-mindedly focused on fighting inflation, “it was,” as Tooze puts it, “taken as axiomatic that central bankers must refuse to monetise government deficits.” Few things would be as damaging to credibility as the idea that money would be “printed” to fund government spending. As much as possible, in the pre-crisis world, central bankers tried to avoid even talking about fiscal policy, while politicians were expected to keep shtum about interest rates.

That pre-crisis world now seems both rather quaint and very distant. In the post-Crashed world, as it were, monetary and fiscal policy have once more become linked. As demand and inflation collapsed in 2008 and 2009, central banks rapidly exhausted their regular ammunition against slumps by cutting interest rates to virtually zero. Meanwhile, discretionary fiscal policy, which in countries like Britain aimed for a brief stimulus in 2008 and 2009, was in most places rapidly refocused on public finance repair. And for all the earlier handwringing about “deficit bias,” voters mostly re-elected governments that promised a tight grip on spending. It was this potentially dangerously depressive combination—of exhausted monetary tools and austere fiscal policies—that jolted central banks into getting inventive. In the Eurozone, Japan and Switzerland interest rates were cut below zero and, in most developed economies, quantitative easing (QE) programmes began. A decade ago, these moves were called “unconventional policy”; today they are almost standard.

Tooze is fascinating on the nature of this “new normal” for monetary policy in rich countries. QE is a reasonably straightforward process: a central bank electronically creates new money and uses this new cash to purchase assets from the private sector—mostly in the form of government bonds. But what exactly is this simple operation actually achieving? That is less clear: Ben Bernanke, head of the US Federal Reserve during the crash, once remarked that QE “works in practice, but not in theory.” It’s probably more accurate to say there are so many rival theories about how it might work, that it is hard to have faith in any of them.

According to monetarist logic, increasing the supply of money should, all things being equal, lead to higher inflation. But all things are rarely equal. The more persistent threat facing the US, the Eurozone and Japan over the past decade (and in Japan’s case longer) has been undershooting inflation (or even outright deflation) rather than soaring prices. 

There are those who argue that QE is a way to “beggar thy neighbour,” by debasing a currency until the point where a country can undercut rivals on price. There was much talk in the early 2010s of “currency wars” and aggressive devaluations, but if QE was genuinely a weapon in fighting for export markets then its value would diminish as other countries joined the party.

Some argue instead that the major point of QE comes from the “portfolio rebalancing” effect. The banks, pension funds and insurance companies that sell their bonds to the central bank find themselves flush with cash, which then has to be put to work elsewhere. It pours into corporate bond and stock markets where, in the best scenario, it finances productive investment. At the very least, it pushes up the price of assets, which makes their owners feel richer and more inclined to open their wallets and start boosting spending across the economy. 

Yet another argument about what made-up money does for the economy, however, would come to the fore in 2020: namely, over “fiscal QE.” In what central bankers insist is a mere side-effect, QE has suppressed the cost of rocketing government borrowing—both directly (since central banks tend to hand back the interest they receive on their debt to the fiscal authorities) and indirectly, by lowering the yield on newly-issued government debt. QE creates space for politicians to adopt a more adventurous fiscal policy by making the costs of servicing debt cheaper. The prospect of that happening, though, brings central banks out in a cold sweat: to them it reeks of “fiscal dominance” and loss of monetary policy independence.

But in the Covid-19 emergency there were soon problems serious enough to overpower such anxieties. Not only did advanced economies experience unusually deep recessions as they locked down, but governments chose to absorb a large share of the hit through furlough schemes, emergency loans, grants, tax breaks and higher benefit payments. As Tooze catalogues, in 2020 some $18 trillion of government debt was issued by advanced economies—“the most spectacular surge in debt in peacetime.” And yet this huge ramping up in issuance was not accompanied by higher borrowing costs: 80 per cent of the total was issued with a yield of under 1 per cent and 20 per cent with negative yield. The amount of public debt may have ballooned, but the actual burden of servicing it fell. QE played a large part in this. The Bank of England, while loudly proclaiming it was not in the business of financing government, embarked on a QE programme which, month by month, almost exactly tracked the government’s borrowing requirements in 2020. An FT survey of the largest fund managers in the British government bond markets in January found that most believed the bank was engaged in fiscal QE—that is to say, absorbing and monetising government debt.

“In two crises, little over a decade apart, central bankers have proved the extent of their ability to shape economic outcomes”

It would be easy to look at the fiscal/monetary mix in 2020 and conclude, as Tooze puts it, that there was “a powerful synthesis of fiscal and monetary policy working in harmonious co-ordination to help fund a generous new social contract,” whether that new social contract took the form of much higher unemployment insurance, as in America, or the furlough scheme in Britain. But, as he argues, this is far too rose-tinted. For while QE may have helped fund new social programmes, it also helped catalyse an asset price boom which handed the affluent 10 per cent “a stimulus that dwarfed anything openly declared in the public accounts.” More importantly, the sea change in monetary/fiscal policy co-operation remains incomplete, confused and contested. Central banks insist they have not monetised government debt and will—eventually—sell it back to the private sector. As Tooze notes, previous attempts during the last decade to “normalise” monetary policy after the (supposedly) emergency measures after the global financial crisis ran into unpleasant reactions and worrying overspills.

Whereas the QE of 2008-2019 was a rich country phenomenon, in 2020 it went global. On a more limited scale, it was to be found in the crisis responses of South Korea, Colombia, Chile, South Africa, Hungary, Croatia, the Philippines, Mexico, Thailand, Turkey, India and Indonesia. As Tooze argues, such bond-buying in “emerging markets” would once have provoked panicked stories about hyperinflation and collapsing currencies; and yet “against the backdrop of gigantic interventions in the advanced economies, markets took the activities of [emerging market] authorities in their stride. The goalposts had shifted.”

Recognising the crucial role played by central bankers in both 2008 and 2020 leads to some of Tooze’s most interesting conclusions. Central bankers, he says, are far from revolutionary; instead he compares them to Bismarckian conservatives trying to preserve a system in the face of upheaval. (“Everything must change so that everything remains the same.”) In two crises, little over a decade apart, central bankers have proved the extent of their ability to shape economic outcomes and “underwrite debt-fuelled speculation and growth.” As Tooze writes, there is no fundamental macroeconomic limit to the ability of this to continue; but it raises important political issues. The question is “whether technocratic governance can keep up and whether society and politics can handle it. Can it be democratised? If not, can it at least be legitimated?” These are big questions—ones that politicians, economists and thinkers will need to grapple with in the decade to come. With government debt burdens in the rich countries now swollen to heights last seen in the 1950s and 1960s, it is unclear if the neat division between fiscal and monetary policy of the early 2000s can be re-established. Indeed, as we saw in August, even mild rumours that central bank support might be withdrawn can trigger a market “taper tantrum.”

Of course fiscal and monetary policy will not be the only thing troubling us in the 2020s. As Tooze writes, one of the most striking aspects of the crisis was the disparity between the scale of the costs incurred (trillions of dollars) and the price of the resolution (mere billions on vaccines). Countries need to find a way of turning the billions currently spent on research and development into trillions. “Otherwise, there is every reason to think that 2020 will be only the first of an increasingly unmanageable series of global disasters.”

A depressing thought. What further complicates the picture is that the world needs to adjust at a time of rising geopolitical tension and a shift to what Tooze calls “a centrifugal multipolarity.” The task of decarbonisation would be tough enough without rising Sino-American competition. 

There will be plenty more books to come on the global economy of 2020. Few will be as timely, as wide-ranging or as clear as Shutdown.