Interest rates are low, and “lower for longer” has become something of a mantra among policy makers, regulators, and other market watchers. But negative interest rates raise an entirely new set of questions. (more…)
Much of Europe rang in the start of 2021 with new lockdowns and weak economic activity. This same period saw the roll out of effective vaccines. While the end of the pandemic will remain a race between the virus and vaccines, there is now light at the end of the tunnel. (more…)
Asian economies are performing better than expected. In the IMF’s latest World Economic Outlook Update, we upgraded our growth estimate for 2020 by 0.7 percentage point from our previous forecast in October, to a contraction of 1.5 percent—in regional terms, a better outcome than other parts of the world. This is largely driven by stronger-than-expected performance among advanced economies in the region, as well as some large emerging market economies such as China, India, Malaysia, and Thailand.
The expectation is for strong growth in Asia-Pacific in 2021 and 2022; but the aggregate figures mask an enormous range of output losses.
Growth outturns in the fourth quarter and higher-frequency economic indicators for industrial, trade, and retail activity point to a strengthening recovery. Output is projected to grow by 7.3 percent in 2021 and 5.3 percent in 2022 but, even if such a reality materializes, output losses from the pandemic will be significant nonetheless.
The aggregate figures mask an enormous range of output losses across economies, from close to zero in China, Japan, and Taiwan PoC to more than 20 percentage points in the Philippines and even 30 points in East Timor. The divergence is especially sobering for the Pacific islands and other low-income countries in the region, where lives and livelihoods will depend on additional international support.
Understanding the Divergence
Divergence is evident when comparing the IMF’s pre-pandemic (October 2019) forecasts with the current cumulative GDP growth projections for 2020, 2021, and 2022 (respectively, the years of impact, recovery, and when herd immunity is expected). Our recent research as well as country experiences identify four main reasons for the large disparity.
Health factors such as the effectiveness of containment measures and the human toll of the disease. The early implementation of stringent containment measures—such as in Australia and Vietnam—proved crucial in flattening the pandemic curve, ensured that medical systems were not overwhelmed and fatalities were reduced, laying the foundation for the recovery. Meanwhile, the rollback of containment measures only after the stabilization of outbreaks and establishment of strong testing and tracing regimes—for example, in China and Korea—were key to boost confidence and pave the way for a stronger rebound in economic activity and better health outcomes.
The magnitude and effectiveness of policy support. Extensive monetary and fiscal support—Japan and New Zealand being notable examples—has helped to mitigate the economic effects of containment measures and facilitated the resumption of activity. Fiscal measures targeted at the most vulnerable households (for example, consumption coupons in Korea and cash transfers to casual workers in Australia) also helped support incomes while affected workers remained at home during lockdowns, reducing the number of infections and laying the ground for higher medium-term growth.
Countries’ economic structure, including the dependence on tourism and contact-intensive service sectors. Containment has hurt all sectors, but tourism has been affected the most. Given the employment composition in the tourism sector, informal and migrant workers, particularly women and youth, have suffered disproportionately from diminished opportunities and lack of access to social safety nets. These effects have been particularly important for the Pacific islands and other countries heavily reliant on tourism, such as Cambodia, the Philippines, and Thailand.
Other structural factors such as informality have exacerbated the economic cost of lockdowns and weighed on the recovery. In the Philippines, the high concentration of economic activity in the Manila metropolitan area, weak transportation infrastructure, low capacity in the health sector, poverty, and a high share of informality, have together significantly complicated enforcement of containment measures and the ability to provide targeted support to the most vulnerable.
The way forward
While the divergent results from last year are history, they are not destiny. Looking forward, four policy priorities will help to shape a better future.
- Ensuring that vaccines are widely available to end the pandemic everywhere. Speedy distribution and availability of effective therapies are key to generate stronger consumption, investment, and employment recoveries, with firms hiring and expanding capacity in anticipation of rising demand. In this respect, support to developing countries in terms of funding, logistics, and administration is crucial to address divergent recoveries and close gaps between developing and advanced economies.
- Policies to support affected workers and businesses should continue until recovery is entrenched and there are signs of a self-sustained revival in private domestic demand. High levels of uncertainty call for a slower withdrawal while remaining vigilant about debt sustainability and financial sector risks.
- Economic transformation. As containment measures are eased, policies to stimulate private sector demand are likely to become more effective and can replace broad sectoral assistance. Building greener, more inclusive, resilient, and digital economies must take center stage once the pandemic is under control. To encourage reallocation, “trampoline” policies, such as job counseling and retraining, should be used alongside safety nets to protect the most vulnerable.
- Financial support from the international community is desperately needed to reverse the increasing divergence between rich and poor countries. Many low-income economies, including the Pacific island countries, have been hit particularly hard by the crisis, have little policy space to respond, and will require financial assistance for the foreseeable future. Global cooperation via the G-20 Common Framework can help clear a path for countries to restructure unsustainable debt and grow.
The Asia-Pacific region went into this crisis first and many of its economies are emerging from it first as well. Indeed, several Asian countries are recognized as having responded highly effectively to the pandemic. Yet the magnitude of output loss is still unprecedented and the weakening of labor force participation and diminished job prospects for youth and women suggest that significant scarring remains likely. All this suggests policy leadership remains critical in the period ahead.
We value innovation and diversity—including in money. In the same day, we might pay by swiping a card, waving a phone, or clicking a mouse. Or we might hand over notes and coins, though in many countries increasingly less often.
Today’s world is characterized by a dual monetary system, involving privately-issued money—by banks of all types, telecom companies, or specialized payment providers—built upon a foundation of publicly-issued money—by central banks. While not perfect, this system offers significant advantages, including: innovation and product diversity, mostly provided by the private sector, and stability and efficiency, ensured by the public sector.
These objectives—innovation and diversity on the one hand, and stability and efficiency on the other—are related. More of one usually means less of the other. A tradeoff exists, and countries—central banks especially—have to navigate it. How much of the private sector to rely upon, versus how much to innovate themselves? Much depends on preferences, available technology, and the efficiency of regulation.
So it is natural, when a new technology emerges, to ask how today’s dual monetary system will evolve. If digitalized cash—called central bank digital currency—does emerge, will it displace privately-issued money, or allow it to flourish? The first is always possible, by way of more stringent regulation. We argue that the second remains possible, by extending the logic of today’s dual monetary system. Importantly, central banks should not face a choice between either offering central bank digital currency, or encouraging the private sector to provide its own digital variant. The two can coincide and complement each other, for example, to the extent central banks make certain design choices and refresh their regulatory frameworks.
It may be puzzling to consider that privately- and publicly-issued monies have coexisted throughout history. Why hasn’t the more innovative, convenient, user-friendly, and adaptable private money taken over entirely?
The answer lies in a fundamental symbiotic relationship: the option to redeem private money into perfectly safe and liquid public money, be it notes and coins, or central bank reserves held by selected banks.
The private monies that can be redeemed at a fixed face value into central bank currency become a stable store of value. Ten dollars in a bank account can be exchanged into a ten-dollar bill accepted as legal tender to settle debts. The example may seem obvious, but it hides complex underpinnings: sound regulation and supervision, government backstops such as deposit insurance and lender last resort, as well as partial or full backing in central bank reserves.
Moreover, privately-issued money becomes an efficient means of payment to the extent it can be redeemed into central bank currency. Anne’s 10 dollars in Bank A can be transferred to Bob’s Bank B because they are redeemed into central bank currency in between—an asset both banks trust, hold, and can exchange. As a result, this privately-issued money becomes interoperable. And so it spurs competition—since Anne and Bob can hold money in different banks and still pay each other—and thus innovation and diversity of actual forms of money.
In short, the option of redemption into central bank currency is essential for stability, interoperability, innovation, and diversity of privately-issued money, be it a bank account or other. A system with just private money would be far too risky. And one with just central bank currency could miss out on important innovations. Each form of money builds on the other to deliver today’s dual money system—a balance that has served us well.
Central bank currency in the digital age will face pressures
And tomorrow, as we step squarely into the digital age, what will become of this system? Will the digital currencies issued by central banks be so enticing that they overshadow privately-issued money? Or will they still allow for private sector innovation? Much depends on each central bank’s ability and willingness to consistently and significantly innovate. Keeping pace with technological change, rapidly evolving user needs, and private sector innovation is no easy feat.
Central bank digital currencies are akin to both a smart-phone and its operating system. At a basic level, they are a settlement technology allowing money to be stored and transferred, much like bits sent between a phone’s processor, memory, and camera. At another level, they are a form of money, with specific functionality and appearance, much like an operating system.
Central banks would thus have to become more like Apple or Microsoft in order to keep central bank digital currencies on the frontier of technology and in the wallets of users as the predominant and preferred form of digital money.
Innovation in the digital age is orders of magnitude more complex and rapid than updating security features on paper notes. For instance, central bank digital currencies may initially be managed from a central database, though might migrate to distributed ledgers (synchronized registries held and updated automatically across a network) as technology matures, and one ledger may quickly yield to another following major advancements. Phones and operating systems too benefit from major new releases at least yearly.
In addition, user needs and expectations are likely to evolve much more quickly and unpredictably in the digital age. Information and assets may migrate to distributed ledgers, and require money on the same network to be monetized. Money may be transferred in entirely new ways, including automatically by chips imbedded in everyday products. These needs may require new features of money and thus frequent architectural redesigns, and diversity. Today’s, or even tomorrow’s, money is unlikely to meet the needs of the day after.
Pressures will come from the supply-side too. The private sector will continue innovating. New eMoney and stablecoin schemes will emerge. As demand for these products grows, regulators will strive to contain risks. And the question will inevitably arise: how will these forms of money interact with the digital currencies issued by central banks? Will they exist separately, or will some be integrated into a dual monetary system where the private and central bank offerings build on each other?
A partnership with the private sector remains possible
Keeping with the pace of change of technology, user needs, and private-sector competition will be challenging for central banks. However, they need not be alone in doing so.
First, a central bank digital currency may be designed to encourage the private sector to innovate on top of it, much like app designers bring enticing functionality to phones and their operating systems. By accessing an open set of commands (“application programming interfaces”), a thriving developer community could expand the usability of central bank digital currencies beyond offering plain e-wallet services. For instance, they could make it easy to automate payments, so that a shipment of goods is paid once received, or they could build a look-up function so money can be sent to a friend on the basis of her phone number alone. The trick will be vetting these add-on services so they are perfectly safe.
Second, some central banks may even allow other forms of digital money to co-exist—much like parallel operating systems—while leveraging the settlement functionality and stability of central bank digital currencies. This would open the door to faster innovation and product choice. For instance, one digital currency might compromise on settlement speed to allow users greater control over payment automation.
Would this new form of digital money be a stable store of value? Yes, if it were redeemable into central bank currency (digital or non-digital) at a fixed face value. This would be possible if it were fully backed by central bank currency.
And would this form of digital money be an efficient means of payment? Yes again, as settlement would be immediate on any given digital money network—just as it is between accounts of the same bank. And networks would be interoperable to the extent a payment from Anne’s digital money provider to Bob’s would be settled with a corresponding move of central bank currency, just as in today’s dual system.
This form of digital money (which we have called synthetic currency in the past) could well co-exist with central bank digital currency. It would require a licensing arrangement and set of regulations to fulfill public policy objectives including operational resilience, consumer protection, market conduct and contestability, data privacy, and even prudential stability. At the same time, financial integrity could be ensured via digital identities and complementary data policies. Partnering with central banks requires a high degree of regulatory compliance.
A system for the ages
If and when countries move ahead with central bank digital currencies, they should consider how to leverage the private sector. Today’s dual-monetary system can be extended to the digital age. Central bank currency—along with regulation, supervision, and oversight—will continue to be essential to anchor stability and efficiency of the payment system. And privately-issued money can supplement this foundation with innovation and diversity—perhaps even more so than today. Where central banks decide to end up on the continuum between private-sector and public-sector involvement in the provision of money will vary by country, and ultimately depend on preferences, technology, and the efficiency of regulation.
Efforts to revive national manufacturing sectors get a lot of airtime. After all, the sector propelled many East and South East Asian economies—the so-called “East Asia Miracle”—and was a gateway to the middle class for millions of workers. However, for all the obsession with manufacturing, economists for their part seem to be more preoccupied with services.
To confirm this, we combed through thousands of IMF reports on countries’ economies from 1978 to 2019. Using 113 distinct terms related to growth theory and policy—ranging from “infrastructure” to “liberalization”—we computed the relative weights of each term across countries and years. As shown in our chart of the week, “services” is used more than any other term.
Many countries entered the pandemic with elevated debt levels. Our new update of the IMF’s Global Debt Database shows that global debt—public plus private—reached $197 trillion in 2019, up by $9 trillion from the previous year. This substantial debt created challenges for countries that faced a debt surge in 2020, as economic activity collapsed and governments acted swiftly to provide support during the pandemic.
Higher debt can potentially reduce the ability of governments to react to the COVID-19 crisis.
Our data show that the global average debt-to-GDP ratio (weighted by each country’s GDP in US dollars) rose to 226 percent in 2019, 1.5 percentage points higher than in 2018. Most of the increase came from higher public debt in emerging market economies and advanced economies outside of Europe. In low-income countries, total debt rose by 1.3 percentage points of GDP in 2019—mostly driven, in contrast, by higher private debt.
As shown in our chart of the week, a dive into the numbers reveals that the 2019 global public debt surpassed its 2007 level by 23 percentage points of GDP. This is primarily driven by the higher levels among advanced economies, where public debt rose from 72 to 105 percent of GDP, and to a lesser degree by emerging market economies (from 35 to 54 percent of GDP) and low-income countries (an increase of 14 percentage points to 44 percent of GDP). Higher debt can potentially reduce the ability of governments to react to the COVID-19 crisis as forcefully as they were able to respond to the global financial crisis (see the January 2021 Global Financial Stability Update). However, many countries benefited from much lower borrowing costs in recent months, partially because very low inflation rates have allowed central banks to keep interest rates at record low levels. Compared to 2007, the average interest bill as a share of revenues was 0.3 percentage points lower in 2019.
Indeed, the high public debt did not immediately restrict the ability of many countries—especially the advanced economies—to borrow to address the crisis. But some highly indebted emerging market and developing economies are starting to find it more difficult to borrow to support the response to the pandemic.
High and rising private debt may also be cause for concern as countries try to transition to a solid recovery.
In the leadup to some past financial crises, we have seen private debt accumulate at a rate far exceeding GDP growth, so this phenomenon can be a warning sign of rising vulnerability. Past experience shows that following credit booms, economic activity tends to suffer. If private debt of households, firms, or both proves unsustainable, it can result in large-scale bankruptcies, which might require government intervention in the form of bailouts of critical sectors or government guarantees on private loans. Private sector debt can therefore pose an additional risk to governments that are already highly indebted. Moreover, as public finances are further stretched during the pandemic, elevated private debt levels before the pandemic can leave governments with less room to maneuver in promoting a healthy and robust recovery.
Global uncertainty reached unprecedented levels at the beginning of the COVID-19 outbreak and remains elevated. The World Uncertainty Index—a quarterly measure of global economic and policy uncertainty covering 143 countries—shows that although uncertainty has come down by about 60 percent from the peak observed at the onset of the COVID-19 pandemic in the first quarter of 2020, it remains about 50 percent above its historical average during the 1996–2010 period.
Uncertainty in systemic economies matters for uncertainty around the world.
What drives global uncertainty?
Economic growth in key systemic economies, like those of the United States and European Union, is a key driver of economic activity in the rest of the world. Is this also true when it comes to global uncertainty? For example, given the higher interconnectedness across countries, should we expect that uncertainty from the U.S. election, Brexit, or China-U.S. trade tensions spill over and affect uncertainty in other countries?
To answer this question, we construct an index that measures the extent of “uncertainty spillovers” from key systemic economies—the Group of 7 (G7) countries plus China—to the rest of the world. In particular, we identify uncertainty spillovers from systemic economies by text mining the Economist Intelligence Unit country reports, covering 143 countries from the first quarter of 1996 to the fourth quarter of 2020.
Uncertainty spillovers from each of the systemic economies are measured by the frequency that the word “uncertainty” is mentioned in the reports in proximity to a word related to the respective systemic-economy country. Specifically, for each country and quarter, we search the country reports for the words “uncertain,” “uncertainty,” and “uncertainties” appearing near words related to each country. The country-specific words include country’s name, name of presidents, name of the central bank, name of central bank governors, and selected country’s major events (such as Brexit).
To make the measure comparable across countries, we scale the raw counts by the total number of words in each report. An increase in the index indicates that uncertainty is rising, and vice versa.
Our results reveal two key facts:
First: Yes, uncertainty in systemic economies matters for uncertainty around the world.
Second: Only the United States and the United Kingdom have significant uncertainty spillover effects, while the other systemic economies play a little role, on average.
Starting with the United States, the chart below displays the global (excluding the United States) average of the ratio of uncertainty related to the United States to overall uncertainty. It shows that uncertainty related to the United States has been a key source of uncertainty around the world since the past few decades
For instance, during the 2001–2003 period, U.S.-related uncertainty contributed to about 8 percent of the uncertainty in other countries—about 23 percent of the increase in global uncertainty from the historical mean. n the last 4 years, U.S.-related uncertainty has contributed to about 13 percent of uncertainty in other countries—with peaks of about 30 percent—and approximately 20 percent of the increase in global uncertainty from historical mean.
Uncertainty related to the U.K.-EU Brexit negotiations has also had significant global spillovers in the last 4 years, with a peak of more than 30 percent and contributing to about 11 percent in the rise in global uncertainty during this period.
Finally, the ratio of uncertainty related to the other systemic countries to overall uncertainty shows Canada, China, France, Germany, Italy, and Japan combined have little uncertainty spillover effects on the rest of the world. An exception is China in the recent years, but most of the China-related uncertainty is due to trade tensions with the United States. That said, while other systemic economies have limited global uncertainty spillovers, they have important regional uncertainty effects—such as for example, Germany for the other European economies and China and Japan for several Asian economies.
2020 will soon be over, and with it an incredibly trying year. The editors at IMFBlog wish you good health and peace over the holidays ahead, and into the new year.
In case you missed some of the compelling facts and figures in our Charts of the Week series this year, we have pulled together your top reads.
Here are the top ten charts of the week for 2020, based on your readership.
The financial industry is undergoing rapid technological change. Traditional banks face competition from online start-ups with no physical branches. Social media and other digital platforms are expanding into payments and credit. The increase in demand for digital services triggered by COVID-19 is turbo-charging this transformation. The confluence we are witnessing is driving fintech innovation and raises important questions. What are the transformative aspects of recent financial innovation that can uproot finance as we know it? Which new policy challenges will the transformation of finance bring?
Fintech’s potential to reach out to over a billion unbanked people around the world, and the changes in the financial system structure that this can induce, can be revolutionary.
Recent IMF and ECB staff research distinguishes two areas of financial innovation. One is information: new tools to collect and analyse data on customers, for example for determining creditworthiness. Another is communication: new approaches to customer relationships and the distribution of financial products. We argue that each dimension contains some transformative components.
New types of information
The most transformative information innovation is the increase in use of new types of data coming from the digital footprint of customers’ various online activities—mainly for credit-worthiness analysis.
Credit scoring using so-called hard information (income, employment time, assets and debts) is nothing new. Typically, the more data is available, the more accurate is the assessment. But this method has two problems. First, hard information tends to be “procyclical”: it boosts credit expansion in good times but exacerbates contraction during downturns.
The second and most complex problem is that certain kinds of people, like new entrepreneurs, innovators and many informal workers might not have enough hard data available. Even a well-paid expatriate moving to the United States can be caught in the conundrum of not getting a credit card for lack of credit record, and not having a credit record for lack of credit cards.
Fintech resolves the dilemma by tapping various nonfinancial data: the type of browser and hardware used to access the internet, the history of online searches and purchases. Recent research documents that, once powered by artificial intelligence and machine learning, these alternative data sources are often superior than traditional credit assessment methods, and can advance financial inclusion, by, for example, enabling more credit to informal workers and households and firms in rural areas.
New communication channels
Communication innovation is driven by the variety of digital platforms in social media, mobile communication, and online shopping that have penetrated much of consumers’ everyday lives, thus increasing their digital footprint and the available data. Platforms like Amazon, Facebook or Alibaba incorporate more and more financial services into their ecosystems, enabling the rise of new specialized providers that compete with banks in payments, asset management, and financial information provision.
Technology again boosts an existing trend. The shift from in-person bank branch visits to remote, online communication generally improves customer convenience and makes financial intermediation more cost-efficient. It also boosts geographic competition among banks, which can now service more distant customers.
The effects of digital transformation are powerful for the financial sector, already the industry most heavily reliant on computers. That is compounded by the doubling in use of online banking having in the past two decades in the European Union’s 15 largest economies. And with usage at 50 percent on average, it still has significant room to grow.
That growth potential ensures that digital innovation in information and communication is bound to deepen even further and give rise to new priorities in several policy areas. Prudential regulation faces perhaps the most substantial challenges. Regulators need to assess the operational risks of new lending technologies and business models facing their first real-life stress test during the COVID-19 downturn.
Other risks also loom large: more cybersecurity risks (financial institutions and customers using more online services creates potential new opportunities for criminals), and regulatory arbitrage (tailoring business models to reduce regulatory oversight). To address all these challenges, regulatory agencies need to ensure that their expertise matches that of the industry—something historically difficult that may become even harder as more talent enters the financial technology sphere and the pace of innovation accelerates.
The environment for monetary policy will change too. The procyclical bias of hard information (exacerbating up- and downswings) might require central bankers to be more “countercyclical,” (i.e., potentially overcompensate with stimulating or cooling measures stronger than actual economic developments would warrant). New monetary policy transmission channels will need to be fully understood. And, as new players make banks less relevant for the financial system, central banks may need to adjust their monetary policy implementation toolbox, potentially allowing nonbanks access to liquidity lines and incorporating them in their operations.
Other critical areas include competition policy, to address the monopolistic tendencies of large digital platforms, related to network effects and the natural tendency to converge to a few large platforms; and data policies to ensure consumer privacy and efficient and safe collection, processing, and exchange of data.
Overall, while much of the technological progress in finance is evolutionary, its pace is accelerating fast. Fintech’s potential to reach out to over a billion unbanked people around the world, and the changes in the financial system structure that this can induce, can be revolutionary.
Governments should follow and carefully support the technological transition in finance. It is important to adjust policies accordingly and stay ahead of the curve.
Arnoud Boot is professor of finance at the University of Amsterdam, Peter Hoffmann and Luc Laeven are economists with the European Central Bank, and Lev Ratnovski is an economist with the IMF (currently on leave) seconded to the European Central Bank. The blog is based on an IMF Working Paper, “Financial Intermediation and Technology: What’s Old, What’s New?” published in August 2020.