(East Ask) Exclusive | Zhu Min and Xu Zhongxiang: What kind of challenges is inflation bringing to the global economy and finance?

  China News Service, Beijing, August 13th, title: What challenges is inflation bringing to the global economy and finance?

  Author Zhu Min, Dean of the National Institute of Finance, Tsinghua University, former Vice President of the IMF, Xu Zhongxiang, postdoctoral researcher at the National Institute of Finance, Tsinghua University

  At the beginning of 2020, the new crown virus has spread globally. By the beginning of August 2021, the cumulative number of confirmed cases worldwide has exceeded 200 million, and the cumulative death toll has exceeded 4.25 million.

This sudden epidemic has caused a serious impact on the global economy and finance. The economies of various countries have experienced a deep recession, unemployment has skyrocketed, stock markets have plummeted, and financial markets have been turbulent.

  In response to this crisis, countries around the world have adopted a series of policy measures to stimulate the economy, stabilize the market, and provide relief to those affected.

However, easing policies have caused global liquidity to overflow, debts continue to rise, and financial risks accumulate.

As the epidemic is gradually brought under control and the economy begins to recover, global macroeconomic and financial policies in the post-epidemic period will face new challenges.

Fiscal stimulus policies in developed countries are stronger than emerging economies

  From the perspective of macroeconomic policies, fiscal policy has played a major role in the response to this crisis. The fiscal strength of developed countries is greater than that of emerging economies.

Overall, the global financial support for the response to the epidemic in 2020 will reach US$14.6 trillion, of which relief measures will reach US$11.0 trillion, recovery measures will reach US$2.0 trillion, and other measures will reach US$1.6 trillion.

The total scale of fiscal stimulus programs varies greatly from country to country.

In many developed countries, the scale of fiscal stimulus accounts for more than 20% of GDP.

The United States has adopted a huge amount of direct financial support, and the total fiscal stimulus scale accounts for 19.1% of GDP.

The Biden administration's $1.9 trillion economic stimulus plan has pushed the US fiscal expenditure on the new crown epidemic to 27% of GDP, which is about four times the scale of fiscal stimulus during the financial crisis.

In contrast, the scale of fiscal stimulus in emerging countries is small, accounting for about 10% of GDP, or even smaller.

Mexico’s fiscal stimulus accounted for about 2% of GDP, of which direct fiscal support accounted for only 0.7% of GDP.

  On the whole, countries around the world have adopted large-scale stimulus policies to alleviate the economic and financial impact of the epidemic. The fiscal and monetary policy support of developed countries is much higher than that of emerging economies.

The measures and beneficiaries of the stimulus policies vary greatly depending on factors such as the development of the epidemic situation, policy space, and social security system in various countries.

In this process, developed economies have coordinated their fiscal and monetary policies to monetize fiscal deficits and at the same time make new breakthroughs in the functional boundaries of the central bank, and balance sheet credit risks have risen.

Under the low interest rate policies of developed countries, emerging economies can adopt loose policies to avoid inflation, but their policy space is very limited.

Nevertheless, the stimulus of fiscal policy and monetary policy has had a positive effect on a global scale.

Fiscal policy and monetary policy space are sharply compressed

  The epidemic stimulus policy continues to compress the fiscal and monetary policy space of countries around the world.

From the perspective of fiscal space, in 2020, the average total deficit of developed economies will account for 11.7% of GDP, 9.8% for emerging market economies, and 5.5% for low-income developing countries.

The U.S. fiscal deficit accounted for 15.1% of GDP, twice that of the 2008 financial crisis and the highest record since World War II. The U.K. and France had larger fiscal deficits of 16.5% and 10.2%, respectively.

The overall deficit of emerging economies is smaller than that of developed countries, with China and India reaching 6.5% and 4.9% respectively.

In advanced economies, the increase in deficit reflects increased spending and decreased income, while in emerging markets and middle-income economies and low-income developing countries, on average, the increase in deficits is mainly due to reduced economic activity.

  Lead to a decrease in income.

Fiscal deficits continue to increase, pushing up government debt that is already at a high level. At the same time, continued fiscal deficits will increase expectations of unsustainable debt, leading to a sharp reduction in the fiscal space of countries around the world.

  After the central bank cut interest rates sharply, the policy interest rates of major developed countries have been at historically low levels. The Federal Reserve's federal interest rate has remained at 0-0.25 basis points. Both the Eurozone and the Bank of Japan have negative interest rates. There is no room for developed countries to lower interest rates.

At the same time, large-scale asset purchase programs have pushed up the balance sheets of central banks around the world.

In 2020, the increase in the Fed’s central bank balance sheet accounted for 15.4% of GDP, and Japan’s 24.6%. The increase in the central bank’s balance sheet of developed economies is higher than that of emerging economies.

As of 2020, Japan’s balance sheet accounted for 133% of GDP, 35% in the United States, and 42% in the United Kingdom, far exceeding the level during the financial crisis.

Low interest rates and expanding balance sheets have sharply reduced the monetary policy space of central banks, especially in developed countries.

  On the whole, after the global stimulus policies, the global macroeconomic situation remains severe.

The economic recovery is uneven, the unemployment rate is still higher than the level before the epidemic, and the employment impact is divergent.

At the same time, the financial market rebounded, the U.S. stock bubble continued, the exposure to sovereign debt of banks in emerging economies increased, risks rose, and the risks of non-bank financial institutions in developed countries still existed.

The stimulus policy has led to a sharp rise in global debt and high government debt.

In addition, the fiscal deficits of countries around the world have risen sharply, the interest rates of developed countries have remained low, their balance sheets have expanded, and their fiscal and monetary policy space has been sharply compressed.

The current global epidemic is still continuing to spread. In this severe environment, the direction of future policies of various countries is facing huge challenges.

Data map: People's Bank of China.

Photo by China News Agency reporter Zhang Xinglong

The core factors that determine the direction of future policies

  The future global policy trend will be continuously adjusted according to the development of the epidemic.

Although the current global vaccines and vaccination have made positive progress, vaccine distribution and global coverage are still difficult.

At the same time, virus mutations and reduced vaccine effectiveness have made the development of the epidemic a huge uncertainty.

The second outbreak in some areas caused a rebound in newly diagnosed cases globally, with the daily increase exceeding 900,000 in April.

Among them, the epidemic situation in India has rapidly escalated. The delta mutant virus discovered by it has spread to 132 countries and regions around the world, and the number of newly diagnosed cases in Southeast Asia and some developed countries is increasing.

  The global epidemic situation is still not optimistic. If the epidemic becomes severe again, it will once again have a serious impact on the private sector, forcing government departments to increase macro stimulus.

  In this process, changes in the future level of inflation are the core factors that determine the direction of future policies.

Under the large-scale stimulus policy, monetary easing, as the economy reopened, demand gradually recovered, and global inflation expectations have begun to heat up.

From the perspective of developed countries, the implied inflation expectations of the U.S. 10-year Treasury bonds have risen sharply, exceeding the level before the epidemic. The highest yield of the U.S. 10-year Treasury bonds has exceeded 1.7%, reflecting market concerns about inflation expectations and commodity prices. The index is also in an ascending channel.

According to IMF forecasts, US inflation will reach around 2.25 in 2022.

At the same time, inflation risks in emerging economies have risen. In July 2020, Turkey's inflation rate reached 18.95%, and Brazil and Russia both exceeded 6%.

  Some additional inflation is necessary to offset the deflationary nature of the COVID-19 crisis and to fund fiscal plans, but it must be moderate, controllable and temporary (Lawson and Feldberg, 2020).

The current global economic recovery is unbalanced, and some sectors with structural problems have a high probability of large-scale price increases. It remains to be seen whether sectoral structural inflation is temporary and controllable (Zhu Min et al., 2021) , But excessive and uncontrollable overall inflation is still cause for concern.

A sharp rise in inflation will force monetary policy to withdraw from easing, posing serious challenges to the economy and finance.

  On the whole, the changes and development of the epidemic will make future policy adjustments, and inflation is the core observation variable in this process, and it is the foundation of loose monetary and fiscal policies.

The worsening of the epidemic will cause global governments to increase stimulus and loose money.

When inflation expectations change, global central banks will be forced to adopt tight monetary policies, reduce asset purchases and raise benchmark interest rates, thereby changing the policy direction.

Monetization of fiscal deficit pushes up inflation

  Historical experience has shown that cutting off stimulus too quickly after a recession will worsen the long-term economic outlook.

During the Great Depression in the United States and Japan in the 1990s, legislators prematurely adopted austerity measures that hindered economic recovery and in some cases caused new recessions.

In the current unbalanced economic recovery, the epidemic has not yet been fully controlled. The developed countries, dominated by the United States, will continue to increase fiscal stimulus to support a soft economic landing and prevent a recession.

  From the US perspective, following the 1.9 trillion stimulus plan, the US Senate passed an infrastructure investment bill totaling about 1.2 trillion yuan.

The Biden administration’s stimulus plan on such a large scale is mainly to prevent the U.S. economy from entering the Great Recession. Once the economic stimulus is insufficient, the U.S. Great Recession will make Trumpism come back in 2022, and it will also deprive the Biden administration of China. Competitiveness.

Therefore, we expect that the Biden administration will increase its stimulus to the U.S. economy at all costs until the U.S. economy is back on track.

  It is difficult to rely solely on taxation to raise funds to meet such a large-scale stimulus plan. Monetization of fiscal deficit financing will be the main source of funds for the government to increase stimulus.

Large-scale stimulus has caused the market’s concerns about inflation to continue to heat up. When the inflation rate rises sharply, the Fed is bound to raise interest rates and tighten liquidity, thereby increasing the government’s debt servicing pressure, and may puncture the US stock market bubble. The institution suffered huge losses.

On the other hand, the expectation of large-scale stimulus will boost the economic recovery, the US dollar index will continue to rise, and the strong US dollar will attract a substantial return of capital and impact the financial stability of emerging markets.

  For emerging economies, many countries may not be able to provide large-scale fiscal policy support for a long period of time due to limited policy space.

If emerging economies continue to increase fiscal stimulus, they will inevitably further increase the debt levels of enterprises, increase investors' concerns about the unsustainable debt of some countries, and lead to an increase in government long-term bond yields.

On the one hand, higher interest rates will increase government financing costs, leading to unsustainable government debt in some countries, triggering debt crises, and the banking industry facing the risk of asset loss due to high sovereign debt exposure; on the other hand, higher government borrowing Interest rates mean that private sector interest rates will be higher, and private sector financing costs will increase, reducing business investment, and putting tremendous pressure on productivity and long-term economic growth.

Data map: Bank staff are counting currency.

Photo by China News Agency reporter Zhang Yun

Emerging market dilemma

  From the perspective of the monetary policies of developed countries, the current economic recovery is uneven and the employment impact is divergent. Central banks will maintain low interest rate easing policies to release credit to support the economy.

When the economic recovery of developed countries led by the United States is on the right track, or inflation rises sharply, the central banks of developed countries are bound to tighten monetary policy, raise interest rates and shrink their balance sheets.

The monetary policy shift of advanced economies will have a huge impact on emerging economies.

  Emerging economies face a dilemma, and the independence of the central bank's monetary policy is challenged.

When the monetary policy of developed economies turns, the US dollar will enter an upward channel and attract capital backflow.

If the central banks of emerging market countries maintain monetary policy independence and maintain low interest rates, emerging countries with low vaccination and weak economic recovery will face the risk of capital outflow, which will impact the stock market and bond market.

At the same time, low interest rates and high debt may increase inflation (Reinhart and Rogoff, 2010), depreciate currencies, and weak exchange rates increase the debt service burden of foreign currency debt in some emerging countries, and may increase import costs and harm the economy. .

If interest rates are raised in advance to deal with capital outflows and curb inflation before the economy has recovered, it will increase the operating costs of the real economy in emerging countries, increase corporate financing pressure and debt servicing pressure, and impact financial market stability.

Emerging economies cannot have both monetary policy independence and free capital flow. The traditional "trilemma" theory will be challenged again in the current environment.

  We expect that in the future, India, Argentina, Malaysia and other countries will continue to raise interest rates to alleviate the upward pressure on inflation risks and the risk of capital outflow. Interest rate hikes will hinder the economic recovery of these countries.

With limited space, some countries may be forced to adopt measures ranging from price controls and trade restrictions to more unconventional monetary policies and easing credit. This series of passive choices will bring greater risks to emerging market countries.

  In summary, the epidemic has had a huge impact on the global economy and finance, and countries have adopted large-scale stimulus policies to stimulate economic stability and financial markets.

Developed economies far surpass emerging economies in the scope of policy options and the scale of stimulus, and overall stimulus policies have produced positive effects on a global scale.

However, the current macroeconomic situation is still severe, the economic recovery is uneven, the employment impact is divergent, the U.S. stock bubble continues, the exposure to sovereign debt of banks in emerging economies has increased, risks have risen, and the risks of non-bank financial institutions in developed countries still exist.

At the same time, stimulus policies have caused global debt to rise sharply, government debt is high, and the space for fiscal and monetary policies in countries around the world has been sharply compressed.

Future policy trends will be continuously adjusted according to the development of the epidemic. Inflation rate has become the core observation variable for policy trends. Developed countries continue to increase their finances. Monetization of fiscal deficits will push up inflation. The shift in monetary policy will challenge the independence of emerging economies' monetary policies. , Emerging countries are facing a dilemma.


About the Author

  Dr. Zhu Min is currently the Dean of the National Institute of Finance of Tsinghua University, the Vice Chairman of the China Center for International Economic Exchanges, the Minister of Finance and Professional Services for the “One Belt and One Road” dialogue mechanism of the State Council, and the high-level independence of the Group of Twenty on the financing of the epidemic response team member.

He is also a member of the "14th Five-Year Plan" Expert Committee, a member of the Foreign Policy Advisory Committee of the Ministry of Foreign Affairs, a member of the Expert Advisory Committee of the Central Cyberspace Administration of China, a member of the United Nations High-level Economic and Development Advisory Committee, and a member of the Lancet Global Anti-epidemic Committee , Co-Chairman of the Green Recovery Sub-Committee.

He is a board member of Fudan University, a managing director of the World Economic Forum, and a board member of the Peterson Institute for International Economics.

Dr. Zhu Min served as the Vice President of the International Monetary Fund from July 2011 to July 2016. Prior to that, he served as the Vice President of the People's Bank of China and the Bank of China.

He worked at the World Bank and worked at John.

Lectures on economics at Hopkins University and Fudan University.

  Dr. Zhongxiang Xu is currently a post-doctoral researcher at Wudaokou School of Finance, Tsinghua University, an assistant researcher at the Institute of National and Global Governance, Tsinghua University, and a former young researcher at the Forty Forum of China Finance.

In 2017, he graduated from the Business School of the University of Nottingham in the UK with a PhD in financial risk. In 2013, he received a master's degree in investment from the University of Birmingham, and a bachelor's degree in finance from Beijing Jiaotong University in 2011.

Dr. Zhongxiang Xu’s research fields include asset pricing, international finance, financial market risks, etc. He has published papers in well-known academic journals at home and abroad, such as Journal of International Money and Finance, International Review of Economics and Finance, and International Financial Research. Multiple articles.