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Source: Bank for International Settlements

MW: I’m delighted to be having this chat this morning with Agustín Carstens, who is the general manager of the Bank for International Settlements, which we sometimes think of as the central banks for central banks. It is a coordinating institution and immensely important. Thank you very much for joining us, Agustín. Perhaps we could start with your evaluation of what the central banks have been doing. The impact of the central banks on this crisis has been extraordinary. Their actions have been extraordinary in every possible dimension. How appropriate and effective have they been?

AC: Thank you very much, Martin. I think they have been very decisive, very determined, as you mentioned they have been massive and, by and large, tremendously effective. I think they managed to buffer the major shock that was implied with the pandemic and the course of action that was decided to address the pandemic. Another key element was that it managed to prevent a real sector shock to be transformed into a financial shock. If that wouldn’t have happened, I think we would have been in a far deeper hole today. Third, I would also say that the complexity of the shock this time was very large because we didn’t only have to do some form of macroeconomic stabilisation effort, but [we also had to] to bring order into markets, into key markets like the treasury bill market to get again the operability of markets.

I think that was also done seamlessly. Now, as we always say, monetary policy cannot fix everything and forever. I would say so far so good, but there are still many, many challenges ahead.

MW: Do you think actually that – and this is sort of strange to say – that we’ve been quite lucky that they had the trial run of the global financial crisis where they learned a lot of these tools and they learned to respond promptly; in fact, because of that, they have been so much more effective and prompt this time?

AC: Yes, definitely, I think that was the case. I think that the speed at which many programmes were rolled out was amazing. I think many programmes were already on the shelf or they needed to be improvised but the drill has been done as you say, therefore, the capacity to respond was there.

I would say also, just looking at it from my point of view here at the BIS where you see all the central banks interact, they spoke the same language. They were all in the same frame of mind, and I think the dialogue among themselves was facilitated because nobody had to explain the severity of the situation, and the conviction that it was time to act was there. I think, yes, we were prepared for this type of shock.

MW: I was actually going to ask you about this, so let us follow up on what you said. One of the things that has struck me is the coordination, the cooperation, at least among the major central banks. Would you agree that this has been remarkable this time?

AC: Absolutely. I think, again, the key for cooperation and the key for acting quick in this type of circumstance is the share of information, the dialogue, and the discussion of where everyone stands, because at the same time, many things are interdependent. In this case, I think the dialogue was there, the information-sharing was there, and the idea-sharing was there. Obviously, central bank needed to act according to the times and the protocols. But by and large, everybody came into sync very quickly.

I would even say that with a very broad scope, it was not only “let’s fix the situation in this particular market or in that”, but “let’s see what else can go wrong”. Take in this case, for example, emerging markets. As you well know, I have a soft heart for emerging markets, and they were not abandoned to their own luck.

MW: Actually, I was going to talk about this: how did you think the interaction with the central banks of the emerging markets has worked? How well have they themselves performed? Because some of them, actually, have been imitating or following the example, in some respects, of the major developed countries’ central banks and their own policies, which is, I think, novel.

AC: Yes, absolutely. Here, what I think is different is the fact in previous cases, when there was a major world shock such as the one where we’re seeing, or some shocks that are more idiosyncratic to emerging markets, the policy response of the advanced economy has not necessarily been in line with what the emerging markets needed. Here, really what happened is that the tremendous and massive response by the advanced economies gave a lot of room for emerging markets to act.

It’s very different. Let’s talk about what the problem is with the emerging markets. Well, it usually is capital relocation, where you have pressures on their exchange rate. What would help you a lot is if the external interest rates would come down. Now, of course, you’re not in control of that. Usually, that’s a given for you. In this case, it was not a given. In this case, it was part of the solution.

Therefore, the massive response of advanced economies to relatively strong emerging market economies gave them enough room even for them to reduce their rates because they were not facing problems of depreciation of capital or necessarily capital outflows given the amount of liquidity that was out there.

MW: One of the response mechanisms, the support mechanisms which are well-known are the swap lines among the central banks and, particularly of course, in the dollar as the world’s leading reserve currency. This has been extended to some emerging countries. Would it be very helpful if this swap line system could be extended further?

AC: Well, I would think so. I think that, by and large, we have, now, a good network. The real problem that there is with respect to swap lines is the fact of providing liquidity in the very, very short term. For a more, let’s say, medium-term adjustment, the IMF is there, and they have a good line of products to support emerging markets. But what really is of the essence, and it doesn’t really have a substitute, is very, very short-term liquidity provision.

Now, of course, the one who can provide these massively, as they’ve shown, was the Fed, and that, by itself, has a huge blanket effect on everything. I think that’s what we saw this time. There is a level of emerging markets, I would say, beyond Mexico, Brazil, Singapore, and others that have also access to the lines that would need some form of support. The holes there are being filled through other mechanisms; the PBOC is providing some and the ECB is being more active in this. There is [also] the Chiang Mia Initiative.

So I would say it’s there, but this is not absolutely solidified. There is also political restrictions to enlarge the size of it, but I think it’s something that we need to work in a more consistent fashion, looking into the future so that we can assure a better infrastructure to provide very short-term liquidity in no time, and the BIS is also doing a little bit of that too.

MW: There has been some discussion at least related to the support of whether there would’ve been some arguments for having a new allocation of special drawing rights to help particularly emerging and developing countries. That would go to everybody. Do you think that would’ve been or would be a good idea?

AC: Well, I would think so. Yes, I think that will be a good idea. I also would think that it would be a good idea to make the SDR be convertible into liquidity, dollar liquidity, or other hard currency liquidity easier. There is not a very well organised market to convert SDRs into liquid currencies. There are formal arrangements, they’re there, but I think that we can do a better job to facilitate the conversion of SDRs into dollars or into euros or into sterling pound. I think that would probably be easier than going all the way to increase the allocations.

MW: One of the interesting things that has happened in this crisis is a change in the way major central banks, notably the Fed, have talked about their inflation objectives and included, as it were, backward-looking elements, an attempt to achieve an average or outcome and not just ignore bygones. Obviously, all this is designed, and explicitly so, to support the idea that the monetary policy will be easier for longer or rates will be lower for longer, and that’s quite a significant shift. I know the ECB is also thinking about its monetary framework. How do you evaluate the benefits and risks associated with such a shift in objectives?

AC: Well, I think that the changes that have been put forward by the Fed makes a lot of sense in the drawing board. I think they are well designed and well thought out. They went through, I would say, a very thorough analysis with the Fed Listens and so on. They invited all types of opinions. I would say that the policy measure makes a lot of sense. I think that the challenge will be in the implementation and how the markets will learn from what is the new, I would say, reaction function of the Fed.

There is still a lot of learning to be done, I would say both from the Fed but also from the market. It’s early to give a final opinion to what the Fed has done. It looks very good. I’m very optimistic about it. I also think that it is introduced in a particularly difficult time because, today, inflationary expectations are affected by many factors, other than the traditional aggregate demand-supply balance, the unknowns about the pandemic, and so on and so forth.

At the same time, it makes sense, from the Fed, to put this on the table because it also provides a very important signal even for the short term. The Fed is saying “we’re not going to be here only doing this to help the pandemic, but also to establish the basis for us to comply with our objective”. I think so far so good, but as I said, a lot of learning on both the market, the household firms and the fact itself is there to be achieved.

MW: Let’s consider now, in this extraordinary circumstance where central banks acted, rightly, obviously, very aggressively, what some of the risks are. I’m interested in your reactions. Some people would argue that this monetary policy has created quote unquote a “bubble” in asset markets, it’s encouraging financial risk-taking, and that this will, as a result, create significant further fragility down the road.

Quite apart from that, of course, the pandemic itself is forcing companies to borrow, non-financial corporates particularly, and there is a huge increase in leverage in small, medium, and large companies. Quite rightly, of course, given the crisis, are we nonetheless facing some very significant financial races down the road?

AC: Well, I certainly agree with that. The important point is that it hasn’t been done with eyes closed. I think that, yes, as we push the pedal to the metal, there are more risks coming on. It’s the same thing if you are driving in Switzerland at 120 kilometers and if you go to Germany, where there is no speed limit, [laughs] the risks are different. You have to be particularly aware of that.

That is the part where I see that there has been a lot of progress. I think the awareness of how well the regulatory environment is, how our mechanics are working to detect vulnerabilities, is much better than in the past. This pandemic has been a good test. I think banks responded well when sailing through this crisis, so far, relatively well. We saw some performance issues on some key markets, where central banks needed to intervene, and we again learned a lot out of it.

There, if you see what is going on in the discussions in the FSB and among central banks, there is a clear conviction that we need to act more in terms of enhancing our regulatory capacity and our monitoring capacity of many of these non-bank financial intermediation instances. Here, the conviction is that monetary policy cannot run by itself, it needs to be accompanied by a very, very appropriate apparatus to supervise, monitor, regulate financial markets, and be able to detect them on time.

My sense is that there is a conviction among many central banks, the key central banks, that they will mind the risks that are out there. So far, they don’t seem to be that present, but they are looming ahead, and we will have to watch it with wide-open eyes.

MW: Let me move to one of the most widely expressed concerns, which is the link with fiscal policy. Obviously and, again, appropriately, governments across the world, particularly in developed countries, have enormously, staggeringly expanded fiscal deficits, debt is rising very rapidly, and de facto, at least at the moment, the central banks are buying a lot of this debt.

The government’s balance sheets are expanding, and the central banks’ balance sheets are expanding. We’ve got holdings of government debt. Now, normal people with a knowledge of history would say “well, this will end up in inflation”. We are going to get what is called fiscal dominance – the central bank will have to support the treasuries, the finance ministries, to manage the debt problems, which might ensue as interest rates rise, particularly if maturities aren’t long. How worried should we be about the medium- to long-run consequences of this extraordinary sort of wartime financing that we are seeing right now?

AC: We’re moving into unchartered territories and, I would say, with control of the dynamics of it. Again, the central banks are going into this in control of their monetary policy. One definition of fiscal dominance is precisely where you can lose control of your monetary policy instruments. So far, that hasn’t happened. I think that there is a conviction out there, and at least, I see it in the main advanced economies, emerging markets, that ministers of finance understand that the fact that the monetary policy and fiscal policy have been able to act in sync, supporting each other, has been the result of an autonomous central bank grouping.

If the central bank wouldn’t have the freedom to act, I think that we would not be where we are today. I think it doesn’t really make sense to threaten that. Now, of course, these fiscal authorities, as we move forward, will have to internalise this because these will not be there forever. If there are higher interest rates at some point, they will have to face the music, and some fiscal restraint will have to come into play.

Now, this is not for today, this is not for next year, for the years to come, yes, at some point, there will need to be some fiscal consolidation. I think what monetary policy can do and has done it effectively is precisely to allow a very quick ramp-up of government spending without turbulences in the market. Otherwise, it wouldn’t have been possible.

But this should be conceived as a step to facilitate the implementing of their very fast fiscal policy [response], not as a new normal. The new normal is that there is free money for everything. No, that’s not the new normal. I’m clear, at least from my perception, that that’s the way it is understood both in ministries of finance and central bank governors.

MW: There is a widely shared, I think of it as a crude monetarist view, that you enormously expanded the central bank balance sheet, you enormously increased what used to be called the monetary base. This will, ultimately, inevitably, permeate through to bank lending and, therefore, to borrowed money. This is bound, in the end, to lead to excess holdings of money, which will lead to inflation, and that it would be very difficult to contain without a brutal reversal of the balance sheet scale, which could be very disruptive.

Others argue for a whole host of reasons, because the central banks pay interest on reserves and others, that actually this analysis is completely wrong. It’s no longer relevant, basically that is my view. What is your view on how we should think about the interaction between central bank money and the overall monetary system?

AC: Well, I think the key element here is that central banks should not push its luck to the point where the credibility of society on money is lost. At the end of the day, in this monetary system we have fiat money. The trust, people accept money and use money because they know that they will be able to change it at a stable price. That basic element shouldn’t be lost. So far, I think that we are safely positioned.

Now, I come from regions of the world where that premise was forgotten or ignored and where even when you started to see that the trust on your own money is being lost, they continue to push. At some point, that breaking point comes. We need to be very aware that that breaking point can come at some point, and often times without much notice. But so farm I think that institutional arrangement in advanced economies and emerging market economies, I think we have made a lot of progress there.

If you see the level of autonomy that central banks have, compared to 30 years ago, it is a completely different picture today than 30 years ago. Central banks can enjoy a fair amount of space to push it. But not to the infinite. Therefore, we need to be prepared for that.

MW: I want to ask one last question. We only have about a minute. It’s a rather different one, but perhaps relevant. There’s a lot of discussion, and you’ve discussed it a lot at BIS, of central bank digital currencies as a really, potentially revolutionary development in which households actually, essentially, hold central bank digital money instead of cash and possibly, disintermediating banks. What do you think of this idea? Is it a good idea, is it manageable, and how risky is it?

AC: Well, I think that it is interesting, it has potential, and it should not be considered as a substitute for cash. I think cash is a perfect invention, and it works extremely well. Therefore, I don’t think we need to push it out. Now, central bank money can facilitate a lot, the innovation in payments. I think that they can help revolutionise even more payments, provided, I would say, a more level playing field.

I think, therefore, that we need to really think seriously about it. The risk of disintermediation, I think, can be handled if you put some limits to the use of central bank digital currency in the same way as there are limits to the use of cash. If you want, tomorrow, 10 million pounds in cash, no bank will give it to you immediately. They’ll probably say “come in three months and with five trucks” and they will take care of you. In the same way, this can happen with central bank digital currency. I think it’s something we need to explore seriously, carefully, and not rush to it. But it has potential.

MW: Thank you very much, Agustín Carstens, for this really fascinating tour de raison of this unprecedented and, so far, we have to say, remarkably successful episode in monetary history. Thank you very, very much.

AC: Thank you Martin. A real pleasure, always great to meet with you.

MW: A real pleasure, thank you very much.

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