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How to Fight the Next Recession

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A crop of fresh ideas along with coordinated monetary and fiscal policies will be needed to combat the next global recession, according to reports from the BlackRock Investment Institute and Insight Investment, a boutique investment firm owned by BNY Mellon.

“There is not enough monetary policy space to deal with the next downturn,” according to the BlackRock report, “Dealing with the Next Downturn,” whose authors include former Federal Reserve Vice Chair Stanley Fischer, a former chairman of the Swiss National Bank and a former deputy governor of the Bank of Canada — all now associated with the institute. 

That’s because global interest rates are either extremely low, as in the U.S., or negative, as in many European countries including Germany and France.

“This channel is almost tapped out,” according to the according to the BlackRock report, referring to monetary policy, noting that one-third of developed market government and investment-grade bonds currently have negative yields.

The low and negative rates correspond to lower-than-expected inflation here and abroad. In the U.S., for example, the personal consumption expenditures index, excluding food and energy — the Fed’s preferred inflation indicator — has failed to reach the Fed’s 2% target since December 2018 and has been fluctuating between 1.5% and 1.8% on a monthly basis ever since.

Still, the U.S. has more flexibility to lower rates than Europe or Japan because it hasn’t moved to negative rates, though the federal funds rate, in a range of 2%-2.25%, doesn’t leave much room for cuts unless negative interest rates are adopted, which would raise legal questions, according to Insight Investment’s white paper, Policy Options in the Next Downturn.

The report offers several options that the Fed could consider employing to address the next recession beyond rate rate cuts and quantitative easing, which it used to combat the Great Recession that ran from December 2007 to June 2009 in the U.S.

“We have already used up a lot of innovative strategies,” said Gautam Khanna, senior portfolio manager at Insight Investment. “We need a fresh set of ideas to help stabilize the next downturn when it happens.” 

Among those ideas included in the Insight Investment report:

  • Alternative inflation targets: price-level targets set over longer periods of time, which would allow higher inflation to offset earlier below-target inflation; average inflation targeting that would differ during recessions and expansions; and temporary price targeting whereby the Fed would not raise rates until price inflation reaches 2%
  • Targeted policies for different business sectors such as tax cuts or capital requirements to stimulate certain economic sectors (or in the case of rising inflation to cool down those sectors)
  • Monetized fiscal expansion, whereby the Fed finances more government spending or federal tax cut.

The latter, also known as “helicopter money,” is “an extreme form” of “going direct,” or getting money directly into the hands of public- and private-sector spenders, because neither lowering  interest rates nor increasing fiscal spending alone will provide the necessary response to the next economic downturn, according to BlackRock.

BlackRock prefers a “practical way” of going direct rather than helicopter money. It would  involve defining the circumstances that call for such a strategy, explicit inflation objectives, a nimble deployment mechanism for fiscal policy and a clear exit strategy, which would take the form of a standing emergency fiscal facility.

“The response to the next downturn will inevitably blur the lines currently dividing monetary and fiscal policy,” the report says. “Without clarifying and adjusting the policy framework, the threat to central bank independence and of uncontrolled fiscal expansion will only get worse in the next downturn.”

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