Central banks must “spin fine” between long-term low interest rates and risks of excess liquidity

SANTO DOMINGO. -One of the main policy challenges of central banks it will be that, when leaving the crisis generated by the COVID-19 pandemic, governments will have more debts and the economy will require low interest rates to achieve its full recovery, according to the representative of the International Monetary Fund (IMF), Frank Fuentes.

The also economist said that central banks will have to "spin very fine" in the process of returning to "normality", and stressed that, by keeping interest rates low for a long time, problems can be created that destabilize the financial system.  

"Central banks are key entities in maintaining stability when we return to something that resembles a new normal, because without stability there is no way that there can be the confidence required for a sustainable recovery," he said.

During the webinar "Fiscal and monetary policies in times of COVID-19: effects on the real economy" organized by the Instituto Tecnológico de Santo Domingo (INTEC), the representative of the IMF, stressed that, without a doubt, the biggest challenge for central banks will be knowing how to combine the highest level of public debt with the need for low interest rates, without harming the financial system.

In this sense, Rolando M. Guzmán, economist and president of INTEC, pondered that the role of central banks and the financial sector in economies is the sap through which all productive activities are nurtured and indicated that precisely for this reason financial problems end up turning into economic crises.

Regarding the implications of the actions that have been implemented in terms of monetary and fiscal policies, Guzmán highlighted three challenges: first, knowing the social sectors that will finally provide the resources to pay for the investments that governments have had to make during the management of the crisis; second, determine how fiscal and monetary policies will be coordinated and, third, manage the distributional effects of the post-pandemic situation.

"The problem is knowing how the necessary adjustment will be made to public finances, and I say necessary because it is evident that it will come. Will it be given through fiscal adjustments that generate a primary surplus in governments, will it be given simply through growth that diminishes the importance of the debt, or will it be given through inflationary financing? ”Guzmán questioned.

The economist pointed out that COVID-19 has generated a disruption in the logistics of world markets and processes at the level of national economies and, therefore, has damaged the behavior of labor markets, which in his opinion are the big generators of income.

“All the investigations reveal that the dynamics of poverty depend to a great extent on what happens in the labor market. This crisis in the context of Latin America has implied that the unemployment rate has increased by 2 points, from a level It was already relatively high, which has meant falls in working hours and income. Today Latin America has 30 million more poor people than it had five months ago and it has 7 million homeless people that it did not have before, ”Guzmán explained.

Effects of monetary policies

The full professor and researcher of the Autonomous University of Santo Domingo (UASD), Fernando Pellerano, highlighted that some effects of monetary policies are that central banks have become broker dealers of secondary markets as well as lenders of last resort. and they have prioritized speculative trading to stabilize financial markets over the traditional function of lending to production companies. 

Pellerano stressed that central banks are closer to quasi-fiscal policies with the financing of public bonds, and called on academia to do research on the redistributive effects of the measures adopted by the Central Bank. The professor also questioned that many economists unreservedly adopt the idea that the Central Bank should be independent, despite the fact that its directors are not elected by democratic vote. 

On his side, José Sánchez Fung, professor of economics at the University of Nottingham, United Kingdom, spoke about the economic, monetary and fiscal projections for the United States and China and indicated that the trade war between the two nations continues, despite the pandemic.  

Professor Sanchez Fung also stressed the importance of central banks being subject to legal restrictions, to prevent them from exceeding the limits established by the social mandate they have received.

The virtual meeting was moderated by Rafael Espinal, coordinator of the Economics and Financial Engineering courses at INTEC.