Financial Stability Factors and the Severity of the Current Recession
November 10, 2020
UBS Eurpean Virtual Conference
Key takeaways from Boston Fed President Eric Rosengren’s Nov. 10 remarks
- Takeaway: Economic shocks happen, but the severity of the consequences depends on how fragile, or susceptible to financial instability, the economy was prior to the shock. In the U.S., excessive risk-taking behavior prior to COVID-19 is likely to delay the recovery, even though the initial response by fiscal and monetary policymakers was a prompt and substantial mitigant.
Excerpts: “Excessive risk-taking during the previous recovery period is, unfortunately, likely to prolong the country’s economic distress – especially for those most disproportionately affected.” “Those economies that go into a recession in more fragile financial condition are likely to experience amplified economic problems that could have been ameliorated with more proactive financial stability steps, taken in advance.”
- Takeaway: The consequences of excessive pre-pandemic risk-taking are seen in the corporate sector, as firms that eventually defaulted after the onset of COVID-19 issued much more debt before the shock. This increased leverage appears to have affected their ability to survive the pandemic downturn.
Excerpt: “Financial factors, including excessive leverage, can influence how severe the consequences of a shock will be, and how painful a recession becomes. Imbalances in the real economy and financial factors accelerating recession dynamics can make the effects of a shock, and the severity of a recession, much worse.”
- Takeaway: Sadly, the impact is tending to be greatest on workers that are least able to adjust and adapt. Workers who are women and minorities may not only be disproportionately impacted by excessive risk-taking by defaulted firms, they are more likely to leave the workforce altogether.
Excerpt: “Those segments of the labor market most affected by amplified business cycles – when financial stability ‘guardrails’ are limited – can be populated by those workers who are most vulnerable and least able to adapt to the changed economic environment. That imbalanced human toll is a bad outcome for democracy as well as the economy.”
- Takeaway: The virus has had a deeper effect in economies that disproportionately involve services, which tend to require more personal interaction than the production and sale of goods. This is because service activities proved to be more affected by the need to social distance.
Excerpt: “In the U.S., consumption of goods now exceeds what was consumed at the beginning of the year, while services consumption remains depressed. Americans have continued remodeling houses and buying durable goods, but things like traveling and recreational activities outside of the home are taking place at a lower rate.”
- Takeaway: This is a time to focus on preventing the buildup of financial imbalances, as many central banks are considering modifying how they respond during shocks. In the U.S., that implies more reluctance to raise interest rates until full employment and 2% inflation are achieved. Rosengren supports these goals, but says they should be accompanied by a more proactive supervisory and financial stability focus.
Excerpts: “Easy monetary policy requires more guardrails protecting against rising financial instability risks. Without financial stability governance and tools, recessions have the potential to be more severe and fall disproportionately on those that can least afford it. And the recessions are likely to be deeper and longer, requiring more fiscal and monetary stimulus than would otherwise be necessary.” “Instead of pushing the unemployment rate below its natural rate, the focus should be on avoiding the subsequent large spikes of unemployment and slow recovery that occur when the downturn is made worse by a lead-up that involves excessive risk-taking and the associated imbalances, both real and financial.”