Of fire in the LINE - OMFIF
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Winter 2021
Vol.12 Ed.1
in the LINE
of fire
The threats to central
bank independencE
Invested in the future.
You don’t thrive for 230 years by standing still.
As one of the oldest, continuously operating financial institutions
in the world, BNY Mellon has endured and prospered through every
economic turn and market move since our founding over 230 years
ago. Today, BNY Mellon remains strong and innovative, providing
investment management and investment services that help our clients
to invest, conduct business and transact in markets all over the world.
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©2019 The Bank of New York Mellon Corporation.
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Contents
Winter 2021 Vol.12 Ed.1
4 ABOUT OMFIF 26
10
WHY RISING PUBLIC DEBT WON’T DRIVE
5 LEADER COUNTRIES INTO DIFFICULTIES
Christian Kopf
6 REVIEW
WORLDVIEW
COVER STORY
28 10 REASONS WHY RENMINBI WILL KEEP
10 IN THE LINE OF FIRE ON RISING
David Marsh David Marsh
15 ECB MAIN TASK IS TO FOLLOW 30 DON’T OVERPLAY THE
RIGHT POLICIES DOLLAR’S DECLINE IN 2021
Danae Kyriakopoulou Mark Sobel
16 SCEPTICISM OPENS DOOR FOR 31 ERA OF LOW INFLATION
CRYPTOCURRENCIES COULD LAST FOR
Steve Hanke 50 YEARS
Meghnad Desai
17 OUTLOOK 2021
30
32 WHY BROWN SHOULD
18 WHAT NEXT FOR RESERVE MANAGERS? BE THE NEW GREEN
Massimiliano Castelli Danae Kyriakopoulou
19 DIGITAL DYNAMISM WILL FUEL 33 THE CASE FOR A
ASIA’S OUTPERFORMANCE EUROPEAN BANKING CHARTER
Taimur Baig Ignazio Angeloni
20 BIDEN MUST ADOPT MULTILATERAL 34 A SURGE IN INFLATION IS ON THE
TACTICS FOR CHINA POLICY HORIZON
Nathan Sheets Juan Castañeda and Tim Congdon
21 AFTER COVID-19, WE REQUIRE A 35 SHEDDING LIGHT ON CHINA’S CAPITAL
NEW FORM OF FINANCE INFLOWS
Joseph Ding Herbert Poenisch
22 MAKING DIVERSITY COUNT INQUIRY
Hani Kablawi
38 OMFIF ADVISERS NETWORK POLL
23 MAKING CBDCS A TRUE AND Ensuring policy harmony
TRUSTED CURRENCY
Wolfram Seidemann
Inquiry
24 BEWARE RISING NEUTRAL RATES
James Sweeney
Cover illustration:
25 SOVEREIGN DEBT CAN BOOST EURO’S
38
Shonagh Rae RESERVE CURRENCY STATUS
@shonaghrae Frank Scheidig
Ensuring
In a speech to OMFIF in November, Bundesbank
President Jens Weidmann stated that central
bankers need ‘to make it very clear that we 93%
OMFIF.ORG WINTER 2021 BULLETIN
are not going to place monetary policy at the
3
policy
service of fiscal policy’, cautioning that ‘if we
create a different impression, we are putting
both our independence and our credibility at
harmony
risk.’ Do you agree?
7%
Poll of OMFIF website users, OMFIF advisory
board and Twitter users Yes No
Talk of monetary policy at the service of fiscal policy is misguided. Both Jens Weidmann correctly frames the issue. As central
are at the service of the economy. The real challenge for central banks and banks increasingly engage in quasifiscal operations and
finance ministries at a time of great financial strain is to work together to their balance sheets grow, it is inevitable that they will be
BTN_Q1.21_0003-005_Bulletin.indd 3 ensure that monetary and fiscal policy are in harmony. subject to more scrutiny and criticism, particularly in a
29/01/2021 15:27
John Nugee, formerly Bank of England populist age. The growing criticism of technology giants
by US politicians of both parties is a powerful example of
No, I do not agree. Extraordinary circumstances call for extraordinary how sentiment can change. To maximise the prospects of
About OMFIF
Dialogue on world finance
and economic policy
OMFIF THE Official Monetary and Financial Institutions Forum is an independent think tank for central
banking, economic policy and public investment – a non-lobbying network for best practice in
ON DEMAND worldwide public-private sector exchanges. At its heart are Global Public Investors – central banks,
sovereign funds and public pension funds – with investable assets of $36tn, equivalent to 45% of
world GDP.
With offices in London and Singapore, OMFIF focuses on global policy and investment themes –
particularly in asset management, capital markets and financial supervision/regulation – relating to
central banks, sovereign funds, pension funds, regulators and treasuries. OMFIF promotes higher
standards, performance-enhancing public-private sector exchanges and a better understanding of
the world economy, in an atmosphere of mutual trust.
Membership
Membership offers insight through two complementary channels – Analysis
and Meetings – where members play a prominent role in shaping the
agenda. For more information about OMFIF membership, advertising or
subscriptions contact membership@omfif.org
Analysis
OMFIF Analysis includes commentaries, charts, reports, summaries of
meetings and The Bulletin. Contributors include in-house experts, advisers
network members and representatives of member institutions and academic
and official bodies. To submit an article for consideration contact the editorial
team at analysis@omfif.org
Meetings
OMFIF Meetings take place within central banks and other official
OMFIF On Demand institutions and are held under OMFIF Rules. A full list of past and
forthcoming meetings is available on www.omfif.org/meetings. For more
gives you the chance information contact meetings@omfif.org
to listen back to our
podcasts and watch
videos of our past OMFIF Advisers Network
The 173-strong OMFIF advisers network, chaired by Meghnad Desai, is
public meetings made up of experts from around the world representing a range of sectors:
monetary policy; political economy; capital markets; and industry and
investment. They support the work of OMFIF in a variety of ways, including
omfif.org/ondemand contributions to the monthly Bulletin, regular Commentaries, seminars and
other OMFIF activities. Membership changes annually owing to rotation.
4 BULLETIN WINTER 2021 OMFIF.ORG
BTN_Q1.21_0003-005_Bulletin.indd 4 29/01/2021 15:27
Leader
Official Monetary and Financial Institutions Forum
6-9 Snow Hill, London, EC1A 2AY
Credible questions for 2021
United Kingdom
T
T: +44 (0)20 700 27898 E: enquiries@omfif.org
www.omfif.org @OMFIF his edition of The Bulletin aims squarely at the big issues that will
dominate discussions among policy-makers throughout 2021, and
BOARD probably for some time after that.
David Marsh, Chairman Will inflation return? Will digital currencies take root? What impact will
John Orchard, Chief Executive Officer
Phil Middleton, Deputy Chairman the Biden administration have on geopolitics, and especially China’s place
Maggie Mills in the world? Will the dollar continue to decline? Can sustainable finance
Jai Arya
Mark Burgess
make the impact it needs to help combat climate change?
Our cover story this quarter (page 10), written by OMFIF’s chairman
ADVISORY COUNCIL David Marsh, directly addresses a question that matters hugely to many of
Meghnad Desai, Chairman
Mark Sobel, US Chairman our members and readers: what is the role of a central bank today?
Frank Scheidig, Deputy Chairman It’s easy to consider issues relating to central bank independence as a
Xiang Songzuo, Deputy Chairman
Hani Kablawi, Deputy Chairman
recent phenomenon, brought on by Covid-19. But the virus has amplified a
Otaviano Canuto, Aslihan Gedik, concern that has been present since at least the 2008 global financial crisis,
William Keegan, John Kornblum,
as Marsh and the policy-making luminaries he interviews point out.
Norman Lamont, Kingsley Moghalu,
Niels Thygesen, Ted Truman, The Bulletin poll on page 38 confirms that many members of the OMFIF
Marsha Vande Berg, Ben Shenglin, Chair,
network share the concerns of central bankers that if monetary policy is
OMFIF Economists Network
placed at the service of fiscal policy, then trust in central banks - the very
EDITORIAL TEAM
Clive Horwood, Managing Editor
credibility that underpins the financial system - is at risk.
& Deputy Chief Executive Officer The problem, perhaps, is that central banks are now operating in too
Simon Hadley, Director, Production
Fergus McKeown, Subeditor
many fields. This has limited their room for manoeuvre, and also given
Sarah Moloney, Subeditor their critics more targets to aim at.
Danae Kyriakopoulou, Chief Economist
The real crunch will come when central banks have to counter
& Director, Research
Kat Usita, Deputy Head of Research inflationary pressures again.
Bhavin Patel, Senior Economist & Head According to most experts,
of Fintech Research
William Coningsby-Brown, Assistant including the authors of our Money
Production Editor Matters column (page 34), that
Pierre Ortlieb, Economist
Chris Papadopoullos, Economist moment approaches. Meghnad
Darrell Delamaide, US Editor Desai, chairman of the OMFIF
MARKETING advisory board, disagrees, saying
Chris Ostrowski, Director, Memberships
‘If monetary policy
we have entered a new, long-term
& Commercial Partnerships is placed at the
Stefan Berci, Communications Manager era of low inflation (page 31).
James Fitzgerald, Marketing Manager
service of fiscal
As always, OMFIF looks forward
policy, then
to promoting discussion, at our
Strictly no photocopying is permitted. It is illegal to
reproduce, store in a central retrieval system or transmit,
trust in central
meetings and in our publications, at
electronically or otherwise, any of the content of this
banks - the very
publication without the prior consent of the publisher.
the highest levels of policy-making.
While every care is taken to provide accurate information,
the publisher cannot accept liability for any errors or
credibility that
omissions. No responsibility will be accepted for any loss underpins the
occurred by any individual acting or not acting as a result Clive Horwood
of any content in this publication. On any specific matter financial system -
reference should be made to an appropriate adviser. Managing Editor
is at risk’
Company Number: 7032533. ISSN: 2398-4236 OMFIF
OMFIF.ORG WINTER 2021 BULLETIN 5
Review: October
»14 October
Africa’s financial » 13 October
markets Canada and the
Americas
OMFIF AND SCOTIABANK’S Global Capital
Markets convened a conference on the Canadian and
other American economies, and how these relate
to developments in Europe and Asia. For sovereign
OMFIF LAUNCHED the fourth annual debt issuers and investors, it provided insights on
‘ABSA Africa Financial Markets Index’. It the main policy and investment themes shaping
records the openness to foreign investment their sectors in 2020-21, including developments in
in countries across the continent. The index fintech and ESG.
is a premier indicator of the attractiveness
and flexibility of Africa’s capital markets, for
use by policy-makers, investors and asset
»15 October »19 October
managers around the world.
Europe’s sustainable Financial
»20 October recovery regulation
The sustainability in 2020
agenda for central WITH EVER MORE actors
and forces influencing financial
banks activities, policy-makers and
market participants must
FOLLOWING the International consider a multiplicity of factors
Monetary Fund-World Bank Group annual in their decision-making. This
meetings, and as sustainability becomes ON THE OCCASION of the International seminar, convened by OMFIF
an increasingly important consideration Monetary Fund-World Bank Group annual and Mazars USA, focused on
in Covid recovery plans, Norges Bank and meetings, DZ BANK and OMFIF convened a panel priorities and challenges in
Banco de México discussed how to embed discussion on Europe’s recovery plan. financial regulation.
climate issues into central bank policies.
»28 October »29 October
Overcoming the Integration, investment and
roadblocks to CBDC financial market developments
OMFIF MET with central bank OMFIF launched a new report, ‘Central America:
representatives to discuss implications of Integration, investment and trade opportunities’,
central bank digital currency and potential produced jointly with the Central American
methods of implementation. The aim of Bank for Economic Integration. It explores the
these sessions was to facilitate informal competitive advantages of the Central American
exchanges between central banks on key Integration System bloc for foreign investment
issues relating to security, financial stability as investors begin to consider opportunities after
and public acceptance of a CDBC. Covid-19.
6 BULLETIN WINTER 2021 OMFIF.ORG
BTN_Q1.21_006-009_Review.indd 6 29/01/2021 16:22:54
November
»19 November
GPP 2020 launch – Funds
face a defining moment
OMFIF LAUNCHED the ‘Global Public Pensions 2020’ report. Public pensions
are at the centre of changes in global finance. The ongoing public health crisis
and economic uncertainty have magnified the relevance of these issues, inevitably
impacting the ability of pension funds to deliver on their obligations. This launch
reviewed the issues covered in the report and presented the findings.
»25 November »18 November
Global economic Addressing climate change with
crisis and gender capital markets
equality AN OMFIF panel
discussed sustainable
bond standards, innovative
finance beyond green
bonds and how capital can
be mobilised for climate
change mitigation and
adaptation.
»5 November
Monetary and fiscal
policy in the face of
Covid-19
THE PANDEMIC HAS exposed an AS THE Covid-19 pandemic plunges
array of economic inequalities, with economies all over the world into crisis,
the economic fall-out of Covid-19 governments have had to respond promptly,
disproportionately affecting society’s most rolling out large-scale fiscal support. Jens
vulnerable groups. The panel discusses the Weidmann, president of the Deutsche
gendered effects of the crisis, focusing on Bundesbank, discussed this and other
the economic impact and policy responses. developments in monetary policy.
OMFIF.ORG WINTER 2021 BULLETIN 7
BTN_Q1.21_006-009_Review.indd 7 29/01/2021 16:22:55
December
»14 December »14 December
Financial services in Covid-19 recovery,
the cloud: A summit European and German
for regulators economic outlook
THE AWS INSTITUTE and OMFIF hosted an Jakob von Weizsäcker, chief economist
invitation-only summit for financial services at the German federal ministry of
regulators in Asia Pacific. The summit was finance, gave an overview of the
an opportunity for policy-makers to discuss state of the euro area economy. He
cloud adoption, best practice approaches to the discussed the shift in geopolitics that
regulation of financial institutions and their Joe Biden’s US presidency will bring,
use of cloud and IT, and to hear from cloud and as well as relations with Asia and euro
security industry experts. The summit consisted area recovery in 2021.
of five 90-minute webinars.
»10 December »16 December
The future of payments Analysis of Brexit
OMFIF LAUNCHED ‘The
negotiations
future of payments’ report
and held a panel discussion
with DMI members. The
panel explored innovations
in electronic payments
and outlined next steps for
national and cross-border
governance frameworks.
It discussed when and
how differing payment
innovations are necessary,
the role of technologies
such as blockchain and the
challenges ahead for public-
private partnerships.
»9 December
China’s global economic William White, former chairman of the economic and
development review committee at the Organisation for
vision Economic Co-operation and Development, joined Robert
Holzmann,
As governor came
Brexit negotiations of thedown
Oesterreichische Nationalbank,
to the wire, Ivan Rogers,
JONATHAN HILLMAN and Agatha Kratz of the Reconnecting Pierrepermanent
former Siklos, professor at the Balsillie
representative School
of the UK of European
to the International
Asia Project joined Mark Sobel to discuss Hillman’s latest book. Affairs,
Union, and Danae
shared Kyriakopoulou,
his thoughts chief
on what was economist
going andthe
on behind
They also covered Chinese commercial lending, the debt service director
scenes. of research
Rogers gave hisatperspective
OMFIF, to discuss his paper on
on the sentiment the five
in Brussels
suspension initiative, sustainability. considerations
before for afinally
the two sides sustainable
reachedrecovery.
an agreement.
8 BULLETIN WINTER 2021 OMFIF.ORG
BTN_Q1.21_006-009_Review.indd 8 29/01/2021 16:23:16
Agenda
»Wednesday 3 February, Virtual
Coming together for sustainability
in 2021
An OMFIF-SEACEN roundtable on the actions on the actions
needed to support sustainability and impactful change in Asia
Pacific in 2021 and beyond. Topics will include the impediments
to achieving the United Nations’ sustainable development goals
by 2030 and the steps needed to overcome these.
»Monday 8 February, Virtual
Euro area stability: view from the IMF
A roundtable with Philip Gerson, deputy director of the
International Monetary Fund’s European department, about the
effects of the pandemic on the euro area economy, setting out
key findings from the IMF’s December report ‘2020 consultation
on common euro area policies’.
»Tuesday 23 February, Virtual
»Thursday 11 February, Virtual Infrastructure in the Covid-19 recovery
Launch of Diem A panel with Jin Liquin, president of the Asian Infrastructure
Investment Bank, and OMFIF’s David Marsh, to discuss the
A panel discussion with Christian Catalini, chief economist at the
emerging infrastructure trends that are shaping Asia’s post-
Diem Association, on the launch of Diem. Catalini will outline the
pandemic recovery and priorities for the bank as he celebrates his
stablecoin’s key features and uses, the regulatory response and
second term with the institution.
associated risks.
»Wednesday 8 March, Virtual
»Monday 15 February, Virtual
Monetary policy of central Gender Balance Index 2021 launch
eastern Europe The launch of the eighth Gender Balance Index. The discussion
will focus on how central banks and public investors can plan
A panel with deputy governors from the Czech, Hungarian and and contribute to a more inclusive recovery, given the pandemic’s
Polish central banks on how central and eastern European disproportionate impact of the pandemic on women and
economies fared with the pandemic and their recovery plans. minorities.
For details visit omfif.org/meetings
BTN_Q1.21_006-009_Review.indd 9 29/01/2021 16:23:34
Cover
The threats to central
bank independencE
in the LINE
of fire
The economic battle against Covid-19 has blurred
the boundaries between fiscal and monetary policy.
But the threats to central bank independence run
deeper than the current crisis.
(it is claimed) increasingly subservient central
David Marsh banks seem to be opting for inflation over default.
OMFIF After all, higher prices inflate away debt – shown
historically by booming economies running out
of control after wars and plagues. ‘Look back
spectre is haunting the world of finance: nostalgically at your time of independence,’
central banks that have lost their power to Goodhart puckishly tells his central banking
shock. Charles Goodhart, veteran professor audiences. ‘It was nice while it lasted.’
at the London School of Economics, a grandee of The debate has heated up. Forecasters point to
international money, has been proclaiming that, a rise in US inflation beyond the Federal Reserve’s
when inflation starts to rise again, these traditional 2% target later this year as the US economy shifts
guardians of rectitude will no longer be able to to major post-pandemic expansion after a decade of
raise interest rates. near-constant undershooting. Treasury Secretary
Over the past 30 to 40 years, central banks were Janet Yellen will not wish overtly to undermine
granted widespread statutory independence from Fed independence, but she will try to swing the Fed
political influence in a sweeping worldwide shift. behind the administration’s pro-growth agenda.
But according to Goodhart’s thesis, they will be Yellen knows her Fed chair successor Jay Powell will
forced to bow to government pressure to keep not want to upset the government by tightening
interest rates low and prevent a ruinous spike in money when bidding for a second term from
the servicing costs of debts massively boosted by February 2022.
the pandemic. There have been frequent squalls over central
Faced with a stark choice, governments and banks’ waning capacity – perceived and real – to
10 BULLETIN WINTER 2019 OMFIF.ORGOMFIF.ORG WINTER 2021 BULLETIN 11
Cover
stand up to governments. The battlegrounds In recent months, including in an OMFIF
include emerging market economies like meeting in November, Jens Weidmann, the
Turkey, Brazil, Nigeria and Malaysia. Also Bundesbank president and former adviser to
included is the UK, where the Bank of Chancellor Angela Merkel, has spoken of a
England is widely regarded as carrying ‘dangerous dynamic’ of ‘fiscal dominance’. He
out monetary financing of a gigantic outlines how central banks risk surrendering
‘Fiscal policy empowers Covid-19 budget deficit – a charge it denies. independence as they ‘jump to the rescue’,
monetary policy by
However, the independence controversy is becoming permanent buyers of debt issued
fostering demand…And
monetary policy makes most virulent in Europe’s 19-nation economic by big-spending governments unfettered by
fiscal policy more and monetary union. After more than 20 market discipline.
effective.’ years, the EMU still resembles an enormous To many, in Germany and beyond, such
financial and political experiment. talk is alarmist and exaggerated. François
Christine Lagarde
The fulcrum of EMU is Frankfurt, where Villeroy de Galhau scotches fears that the
Germany’s Bundesbank was set up after the ECB is in danger of losing clout. At an OMFIF
second world war with strong legal powers session in September the silken-tongued
to withstand government pressure, guarding Banque de France governor countered
against the excesses of the Weimar Republic traditional German views by suggesting the
and later the Third Reich. Germany’s Weimar ECB should more directly widen its mandate
hyperinflation in the 1920s was part of a grim beyond targeting purely price stability. The
chain of money printing episodes ruining Bundesbank, once a synonym for German
‘It is good to have currencies and breaking political systems – monetary hegemony, has lost sway with the
implicit co-operation linking ancient empires to modern emerging birth of the EMU. Weidmann has maintained
between monetary and markets like Argentina, Venezuela and opposition to some of the ECB’s furthest-
fiscal policy. This is
not a loss of central Zimbabwe. reaching credit-easing actions. Yet he has
bank independence.’ Established in 1998, the European Central accepted that the Bundesbank generally
Bank was modelled on the Bundesbank, must give way to a built-in majority on the
Marcel Fratzscher with its independence enshrined in the 25-member ECB governing council favouring
European treaties. Now, the model appears a relatively accommodative monetary stance
to be faltering. Conservative Germans Mario Draghi, ECB president in 2011-19,
voice concerns that enormous central bank was frequently embroiled in disputes with
government bond purchases before and the Bundesbank chief. Draghi’s successor,
during the Covid-19 upheavals (Figure 1) are Christine Lagarde, a former French finance
turning these institutions into appendages of minister and International Monetary Fund
finance ministries. managing director, has taken a far more
‘My worries about
independence do not 1. Central bank
stem from concern about 25
balance sheets have
fiscal dominance, more exploded
because of the range of 20
non-traditional fields Asset purchases by
that central banks 15 selected central banks,
now seek to address, $tn
10
such as climate change Source: respective
measures and gender central banks, OMFIF
5 analysis
balance. They are
dabbling in issues that 0
are more difficult to
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Jan-18
Jan-19
Jan-20
Jan-21
control, measure and
communicate.’ Bank of England Federal reserve European Central Bank
Bank of Japan Bank of Canada Swiss National Bank
Barry Eichengreen
12 BULLETIN WINTER 2021 OMFIF.ORGconsensual line to heal rifts between council 100
2. Growing NGFS
‘hawks’ and ‘doves’. But Lagarde has dropped signals central
90
not-so-subtle hints that quantitative easing
banks’ commitment
80
on climate change
purchases of government bonds may continue 70
Number of members of
indefinitely. 60 Network for Greening
One leading southern European governor Financial System since
50
on the ECB council fiercely opposes his 2017
40
colleagues calling for a gradual credit Source: NGFS, OMFIF
30
tightening as Europe slowly brings the analysis
20
pandemic under control. ‘I am a strong hawk,’
10
he tells OMFIF, ‘in opposing deflation.’ There
0
were sharp exchanges at the ECB’s meeting Dec-17 Dec-18 Jul-19 Sep-19 Dec-19 Jul-20 Oct-20 Dec-20
Number of members Number of observers
on 10 December when it decided to boost
emergency bond buying by ¤500bn and
extend it to March 2022. Council members
swapped jibes about whether the ECB the ECB. This danger is intensified if the ECB
was taking seriously its mandate to boost is following too many targets in the political
inflation to ‘below but close to 2%’ – a level it field, for example in measures to alleviate
has undershot for eight years. climate change, (Figure 2) which weaken the
Marcel Fratzscher, a former ECB official focus on its primary goal of stability.’
who heads the Berlin-based German Institute ‘When inflation Barry Eichengreen, economics professor at
for Economic Research (DIW) believes the starts to rise again, the University of California, agrees with the
Bundesbank’s narrative on inflation and central banks will second part of Schlesinger’s argument. He
independence is overdone. Fratzscher echoes
be unable to tighten backs the Lagarde and Fratzscher view that
money in response.’
a persistent Lagarde theme: the need for central banks can retain independence under
coordination between central banks and Charles Goodhart fiscal and monetary policy harmonisation. He
governments. As Lagarde puts it: ‘Fiscal adds: ‘My worries about independence stem
policy empowers monetary policy by not from concern about fiscal dominance,
fostering demand … And monetary policy critics, a transformation towards a system for more because of the range of non-traditional
makes fiscal policy more effective.’ permanently channelling wealth and income fields that central banks now seek to address,
Fratzscher tells OMFIF: ‘It is good to have from higher- to lower-performing areas of the such as climate change measures and gender
implicit co-operation between monetary EMU may be on the way. balance. They are dabbling in issues that
and fiscal policy. This is not a loss of central Helmut Schlesinger, former Bundesbank are more difficult to control, measure and
bank independence. Even if central banks president, at 96 a Methuselah of monetary communicate.’
were unhappy with fiscal polices, they would orthodoxy, tells OMFIF: ‘I am worried there Underlining the diversity of opinions,
be breaching their mandate if they raised is no real resistance to the ECB’s very large Athanasios Orphanides, a former governor
interest rates to force governments to change purchases of government bonds, which of the Central Bank of Cyprus and member
their behaviour. It’s not the job of central represent a form of state financing not of the ECB’s council, complains the ECB has
banks to discipline governments.’ He adds, ‘If allowed by the treaty. It seems to me that used the broad language of the European
inflation were to rise for a sustained period Chancellor Merkel and her government treaty to set its own goals, for example in
substantially above the ECB’s mandate, then didn’t recognise the concerns raised in this defining ‘price stability’ - and yet has not
it would have to act decisively, and I am sure matter in May by the German constitutional done enough to produce higher inflation.
it will.’ court [when it voiced concerns about illegal He tells OMFIF: ‘Central banks should
Behind the divergences over monetary financing].’ have the independence to meet their
‘harmonisation’ lies a deeper question. He adds: ‘There seem only two or three goals but not to set them. The ECB has
European governments have still not resolved members of the ECB governing council who too much independence and insufficient
whether, longer term, the euro area requires a speak out against these policies. The close accountability.’ He claims that the ECB has
fully-fledged political union to back the ECB’s linkage between fiscal and monetary policies misused independence by following overly
monetary integration. According to German presents a danger for the independence of tight Bundesbank-style policies that have
OMFIF.ORG WINTER 2021 BULLETIN 13Cover
3. US implied
2.5 inflation
expectations
2.0 climbing
5-Year, 5-Year Forward
‘The close linkage between 1.5 Inflation Expectation
fiscal and monetary Rate, Percent, Daily, Not
policies presents a danger 1.0 Seasonally Adjusted
for the independence of Source: Federal Reserve,
the ECB. This danger is 0.5 OMFIF analysis
intensified if the ECB is
following too many targets 0.0
in the political field.’
Jul-19
Jul-20
May-19
May-20
Jan-19
Jan-20
Jan-21
Mar-19
Sep-19
Mar-20
Nov-19
Sep-20
Nov-20
Helmut Schlesinger
raised euro area credit spreads and damaged ECB’s 1998 definition of price stability as an
growth. Now a professor at Boston’s MIT inflation rate of below 2% over the medium
Sloan School of Management, Orphanides term, but added the refinement of ‘close to’
– who previously worked at the Fed – to safeguard against deflation. He believes
stresses the contrast with the US: ‘If the the ECB will not signal it is going soft on
Fed starts making systematic policy errors, inflation. ‘This time I believe the ECB might
‘Central banks should
Congress can change the law and hold the simply settle on a figure of 2%. The question have the independence
Fed accountable. The ECB should not be so is: Will the ECB see this goal as symmetric, to meet their goals
independent that its policy errors cannot be i.e. will it deal with both overshooting and but not to set them.’
corrected.’ undershooting in similar fashion.’
Athanasios
The ECB’s framework is coming under The fundamental problem facing central Orphanides
renewed scrutiny in the bank’s strategy banks has been recognised for years: they
review due to be unveiled in early September. are operating in too many fields. As veterans
The process gives Weidmann and other like Schlesinger and Issing emphasise, the way back – a view gaining ground because of
governing council hawks unaccustomed widening of central banks’ sphere of action the Biden recovery plan, signalled by rising
influence. Otmar Issing, the ECB’s first board since the 2008 Lehman Brothers bankruptcy longer-term US interest rates (Figure 3).
member for economics, oversaw the only into areas like banking supervision, as well ‘Once vaccination has overcome the
other previous review in 2003. He points as large-scale QE, has limited their room Covid-19 pandemic, say by summer 2021, a
out how the council’s stringent minority for manoeuvre. A 2012 OMFIF-EY report, surge in consumer expenditure and demand
– normally submitting to the majority on ‘Challenges for central banks: wider powers, could lead to a blip in inflation. If that does
operational decisions – will have an effective greater constraints’, underlined far-reaching not exceed 5%, central banks will probably
veto on the outcome of the strategy review, questions about their operational freedom. welcome the counterbalance to the previous
including on the hot topic of climate change, The LSE’s Goodhart sees the threats undershoot, claiming it is purely temporary.’
where Weidmann and other orthodoxists growing mainly outside Europe. ‘The More likely, Goodhart believes, is that
oppose interventionism that could expose the central banks in Japan and India have lost inflation will remain significantly higher
ECB to conflicts with its monetary goals. ‘The their independence, Latin America never than targeted in 2022-23. This will lead to
review should end in unanimous support had it, the US is on the verge of losing it. different scenarios including conflict with
for the decision,’ Issing tells OMFIF. ‘This The independence of the ECB is protected politicians, most of them with unpleasant
will not easily be achieved. Compromises by treaty – but I’m more worried about Jay outcomes. ‘Ultimately the political
are needed, but the result must deliver a Powell.’ Faced with Yellen in the Treasury, authorities have the whip hand, whether
consistent approach.’ Goodhart says fiscal dominance seems on the in authoritarian or democratic countries.
The review is expected to result in ‘not way in the US. ‘I think he will do whatever Central banks must be aware where their
too much change’ in its inflation framework, she likes.’ limits lie.’
Issing says. The 2003 review upheld the As for inflation, Goodhart thinks it’s on the David Marsh is Chairman at OMFIF.
14 BULLETIN WINTER 2021 OMFIF.ORGECB main task is to follow right policies
Fears over fiscal dominance and market neutrality are misguided
This ability is preserved by pursuing Lagarde have pondered whether such
Danae
the right policy options and delivering assets should be eligible for the ECB’s risk-
Kyriakopoulou
results, not by refraining from doing so to constrained investment universe. Lagarde
OMFIF
defend a reputation for independence for warned of market failure and suggested
independence’s sake. that financial markets may ‘not actually be
V accines are a light at the end of the
health crisis tunnel. But the economic
effects of Covid-19 remain longer lasting.
As ECB Executive Board Member Isabel
Schnabel says, the euro was built on the
principle of ‘monetary dominance’, with
measuring the risk properly’.
Others are more sceptical. Weidmann,
while acknowledging that ‘central bank
Even with the pandemic emergency the central bank’s objectives ‘determined independence is not an excuse for inaction’,
purchase programme, asset purchase by its mandate as defined in the European has insisted that ‘it is not up to them to
programme and targeted longer-term treaties’. So long as bond purchases make correct market distortions and political
refinancing operations on the European economic sense, central bank credibility is actions or omissions’. He questions whether
Central Bank’s table, there are limits to what not at risk. And in today’s context, they do. ‘central banks should become engulfed
monetary policy can contribute to Europe’s Interest rates are at the lower bound, leaving in politics and undermine their own
recovery. Targeted fiscal support remains asset purchases key for delivering price independence’. Instead, he argues that
the most powerful tool to address the stability. governments should adjust carbon prices.
pandemic’s economic ramifications. Governments have yet to do so but have
However, there are worries over ‘fiscal committed to action through the Paris
‘Fears about central
dominance’, whereby monetary policy is banks losing their agreement. Central banks evaluating the
forced to accommodate high levels of public independence through risk of assets in their portfolios can assume
debt. In his OMFIF speech in November, fiscal dominance that the prices are heading in one direction
Bundesbank President Jens Weidmann or loss of market only – and it is not one that justifies their
stated that central bankers need ‘to make
neutrality are presence on the ECB’s CSPP.
misguided. Worse still,
it very clear that we are not going to place they can be dangerous By focusing on ‘market neutrality’, the
monetary policy at the service of fiscal if they discourage them ECB may be missing a chance to reduce
policy’, cautioning that ‘if we create a from pursuing the right portfolio risks before a sudden reversal
different impression, we are putting both policies.’ prompted by excessive bullishness –
our independence and our credibility at economist Hyman Minsky’s feared ‘Minsky
risk’ (See this quarter’s Bulletin poll, on The same applies to another source of moment’. In taking action to address market
page 38, to learn if OMFIF members agree fear: climate change action. So far, this has failure central banks are not playing politics
with Weidmann). Former ECB Executive focused on supervision. Few have addressed and sacrificing independence. Rather,
Board Member Otmar Issing argues that climate risks in their own portfolios, they are protecting balance sheets against
‘central banks are caught in a trap of their whether in reserves management or asset underpriced risk.
own making’ and wonders whether ‘they purchases. Misguided fears about waning
will be able to escape the regime of fiscal For the ECB, this is due to the ‘market independence through fiscal dominance or
dominance and retain their independence’. neutrality’ principle that guides its loss of market neutrality can be dangerous.
Such fears are misguided. True, the corporate sector purchase programme to be Such concerns could discourage central
pandemic is strengthening links between in proportion with the market. Given the banks from pursuing the right policies.
fiscal policy, monetary policy and concentration of carbon-intensive industries By using the tools appropriate for the
government debt management. But central in the corporate bond universe, this has conditions, central banks will enhance, not
bank independence is rooted in institutions’ resulted in a carbon-biased portfolio. lose, credibility and independence.
ability to deliver stable prices when there are The ECB should rethink market neutrality. Danae Kyriakopoulou is Chief Economist
calls for economically unjustifiable stimulus. Both Schnabel and President Christine and Director of Research at OMFIF.
OMFIF.ORG WINTER 2021 BULLETIN 15
BTN_Q1.21_000_Bulletin.indd 15 29/01/2021 15:32Cover
Scepticism opens door
for cryptocurrencies
Central banks could be overtaken by private substitutes
trust, particularly in the modern era of fiat most notable is the Swiss National Bank.
Steve Hanke
money—and for good reason. Over the past In the last 120 years, Switzerland has
Johns Hopkins 120 years, central banks have produced experienced the world’s lowest average
University a great deal of inflation, which has been annual rate of inflation. Unsurprisingly,
accompanied by a loss in the purchasing the Swiss franc has appreciated against
W hen delivering the BBC’s ‘A Question of
Trust’ Reith lectures in 2002, Baroness
Onara O’Neill recounted advice given by
power of their currencies. At times, bouts of
hyperinflation have reared their ugly heads.
Currencies have been rendered worthless
all other currencies over that period. In
consequence, unlike most central banks, the
SNB commands a great deal of trust.
Confucius to his disciple, Tzu-kung. He overnight.
revealed that a government needed three Consider what has happened in Venezuela, Creating order
things to survive: weapons, food and trust. Zimbabwe and Lebanon during the past year. The public is always in search of alternative
If a ruler cannot hold onto all three, which On 31 December, I measured the annual institutions and reliable arrangements that
one should be given up first? For Confucius, inflation rates in those top three inflators work. Carl Menger, founder of the Austrian
weapons were the most expendable, and to be 1,945%, 395% and 274% respectively. school of economics, formulated the process
then came food. But a ruler should attempt Inevitably, the bolivar lost 94.5% of its value by which institutions are created and evolve.
to hold onto trust at all costs, for ‘without against the dollar last year, the Zimbabwean This has come to be known as spontaneous
trust we cannot stand.’ dollar lost 79.5% and the Lebanese pound order, an order that is not consciously
This is widely understood by central lost 72.6%. It is difficult to trust central designed by anyone. For example, a V
bankers. But few have been able to banks that issue currencies such as these. formation of migrating geese does not
implement policies that have garnered much There are exceptions, but very few. The exist because one goose ordered it. Menger
demonstrated that it was spontaneous order
that gave rise to money. No one invented
money. Instead, money emerged unplanned
out of people’s attempts to improve their
condition by moving away from bartering
and by engaging in indirect exchange via
money.
This brings us to the rise of
cryptocurrencies. Lack of trust in central
‘Money emerged
unplanned out banks and national currencies set the
of people’s stage for the spontaneous arrival of private
attempts to substitutes. While technology played its
improve their part in making cryptocurrencies feasible, it
condition is the lack of trust in central banking that
by moving
away from has paved the way for what might be a new
bartering and spontaneous order.
by engaging Steve Hanke is Professor of Applied
in indirect Economics at Johns Hopkins University
exchange via and a member of the OMFIF Advisory
money.’
Board.
16 BULLETIN WINTER 2021 OMFIF.ORG
BTN_Q1.21_000_Bulletin.indd 16 29/01/2021 15:32Asia
The end of Covid?
The return of
inflation? The rise of
digital? Our panel of
experts predict what
what will define the
year ahead
OUTLOOK
2021
OMFIF.ORG
BTN_Q1.21_000_Bulletin.indd 17
WINTER 2021 BULLETIN 17
29/01/2021 15:32OUTLOOK 2021
What next for reserve
managers?
Central bank portfolios have moved into more assets than
just government bonds, but further diversification looks
essential, writes Massimiliano Castelli, head of strategy,
sovereign institutions at UBS Asset Management.
OVER the last decade reserve managers which generated a return of more than 4%.
have increased diversification. A growing Reserve managers adopting diversification
number of central banks are now investing have been able to fulfill their policy goals
across a wider range of asset classes. including liquidity preservation, capital
According to the most recent UBS Reserve protection and return.
Management Survey, in 2020 more than While the inclusion of equity requires an ‘Reserve
90% of central banks surveyed are invested increase in risk limits in terms of maximum managers’ portfolios
in US agencies, two-thirds are invested in drawdown, the volatility of the entire look increasingly similar to
corporate bonds and nearly half of those portfolio increases only slightly when
those of other institutional
central banks surveyed are eligible to compared to a fixed income-only portfolio.
invest in listed equities. Reserve managers’ This is a result of benefits generated by the
investors such as pension
portfolios look increasingly similar to those inclusion of equity in a portfolio dominated and insurance funds.’
of other institutional investors such as by fixed income assets.
pension and insurance funds. So what’s next for reserve managers? The
The sharp market sell-off in February/ main challenge currently faced by reserve of their reserves, or continue along the
March 2020 was the first big test of market managers is the low yield environment. diversification path. Reserve managers who
stress faced by reserve managers since According to the UBS survey, the majority of are pondering further diversification steps
the 2008 financial crisis. And the test was institutions surveyed expect interest rates in should consider: further diversifying away
successfully passed. According to the UBS the US and the euro area not to start rising from advanced economies’ government
RMS Survey, nearly half of central banks before 2023 as central banks maintain a very bonds; increasing allocations to Chinese and
that are invested in equities rebalanced their loose monetary policy stance in the post- other emerging markets bonds; increasing
equity holdings to return to their equity Covid world. allocation to equities to above 20%.
allocation target. And more importantly, This will lead to a dramatic fall in returns on Central banks with high levels of reserves
while a shift to more ‘defensive’ assets is reserves when compared to the last decade and less liquidity constraints should consider
visible in 2020, the ‘secular’ trend towards as the fixed income boom ends. According allocations to real estate and infrastructure
diversification remains intact with equities to our estimates, in the next five years a to enhance returns and generate further
now being an eligible asset class for about portfolio invested into investment grade diversification benefits.
45% of central banks, a new all-time high. fixed income assets only will generate a According to our estimates, over the next
The diversification of reserves away from return below 1%. Even a portfolio diversified five years a portfolio with emerging market
government bonds has been a winning into equities – as the one discussed above bonds (in hard currency) at 15% and equity
strategy so far. Since 2009, according to – will generate a return of less than 2%, less at 20%, with the rest in government bonds
our estimations, a liquid portfolio invested than half the return generated since 2009 and investment grade spread products, will
50% into cash and government bonds and lower than inflation. generate a return of 2.4% with a volatility
from advanced economies, 35% into Reserve managers face a choice: still below 5%. That is less than in the past,
investment grade spread products and 15% either accept much lower returns than but capable of protecting the real value of
into advanced economies’ listed equities in past, failing to protect the real value accumulated reserves. ♦
18 BULLETIN WINTER 2021 OMFIF.ORG
BTN_Q1.21_000_Bulletin.indd 18 29/01/2021 15:32Digital dynamism will fuel
Asia’s outperformance
A week-long trial of a central bank digital currency in Shenzhen may
have been a glimpse of the future, writes Taimur Baig, chief economist
at DBS Bank.
FROM digital bank licence approvals in Beijing is on the cards. continue to lead in the area of digital
Singapore to the roll-out of the e-RMB PBoC is working with lifestyle apps, currency usage, interesting developments
initiative in China, digital finance picked including ride-hailer Didi Chuxing and are afoot elsewhere too. The National Bank
up momentum in Asia through the year food delivery company Meituan, with plans of Cambodia recently launched the Bakong
of the pandemic. Just like the rest of the to make the digital currency available payment system, a common platform
world, the pace of e-commerce adoption for online transactions in the upcoming for commercial banks, microfinance
soared as consumers and businesses experiments. The authorities are also institutions and payment service providers
favoured remote transactions. Monetary testing new functionalities like offline, to deliver e-wallet and money transfer
authorities in Australia, Cambodia, China, phone-to-phone (just by tapping one services to consumers without the need for
Hong Kong, Singapore, South Korea, and device to the other) transfers. Indeed, a bank account. It facilitates transactions in
Thailand made forays in central bank digital the next step could be to provide access both dollars and riel by scanning QR codes
currencies, launching pilots to explore legal to e-RMB even without a phone number or inputting the phone numbers of payees.
framework, settlements, and cross-border or bank account information. This makes The platform should simplify payments and
payments. sense since CBDC is legal tender that can promote financial inclusion.
The developments in China are be exchanged without needing a bank as We expect 2021 to be a year of Asian
particularly noteworthy. In October, over an intermediary. Such a development could outperformance as the region surfs
47,000 consumers in Shenzhen spent facilitate CBDC use by foreigners, who can a favourable trade cycle, successful
Rmb8.8m at 3,389 designated shops directly exchange foreign currencies for pandemic management and pull from
during a week-long trial of People’s Bank the digital yuan without carrying cash or an accelerating China. Digital finance
of China’s digital currency. Users also opening an onshore bank account. developments will be a constant, adding
transferred credit into the official digital While China’s public and private sectors dynamism to the world’s growth engine. ♦
Renminbi app, which can be used well after
the end of the trial.
Tests have also taken place in Suzhou,
Chengdu and Xiongan. In Suzhou, the
e-RMB has been used for paying salaries
to some public servants, while in others
‘The developments in
the focus has been on retail. More than China are particularly
Rmb2bn has been spent using China’s noteworthy. In October,
new digital currency in 4m separate over 47,000 consumers in
transactions, according to the PBoC. Shenzhen spent Rmb8.8m
The next batch of pilot programmes will
likely include other major metropolitan
at 3,389 designated shops
areas such as Beijing, Tianjin, Shanghai, during a week-long trial of
Guangzhou and Chongqing. A countrywide People’s Bank of China’s
launch by the 2022 Winter Olympics in digital currency.’
OMFIF.ORG WINTER
WINTER2021
2021 BULLETIN 19
BTN_Q1.21_000_Bulletin.indd 19 29/01/2021 15:32OUTLOOK 2021
Biden must adopt multilateral
tactics for China policy
Relations between the US and China will remain fraught, albeit more diplomatic,
writes Nathan Sheets, chief economist and head of global macroeconomic
research at PGIM Fixed Income.
AS recently as five years ago, there was a zeitgeist and gave it voice. Even so, Trump’s renewed discussions with partners in Asia,
vigorous debate in Washington regarding tactics failed to win broad support. His trade Europe and on World Trade Organisation
US policy towards China. Today, that debate war, sanctions against Chinese technology reform.
is over. The broad consensus — among both companies and other restrictions have That said, two caveats are necessary.
Republicans and Democrats — is that the been criticised as hurting the US as much as First, given US political realities, it would be
US-China relationship is necessarily one of China. The pain has been amplified by the difficult for the Biden administration to roll
‘strategic competition’. The US must lean unilateral nature of the actions. back quickly the tariffs and other measures
against China’s rise using the broad range of The Biden administration is expected to that Trump has put in place. Second, the
tools at its disposal. pursue an alternative path. US concerns recent comprehensive agreement on
Some advocates of this view highlight about Chinese actions are broadly shared by investment between the European Union
the trajectory of China’s policies under many other countries. The US has scope to and China was no doubt a disappointment to
President Xi Jinping — including the stunted work with its allies to press China to reform the Biden team, but the scope for broad co-
progress in establishing a level playing and open up. Broad-based diplomatic operation with the US persists nonetheless.
field for foreign firms, China’s handling of efforts could seize the moral high ground US-China relations are to remain fraught.
foreign technologies and (more recently) and intensify pressure on China. The Biden administration will continue to
the actions against Hong Kong. Others What this looks like in terms of concrete press China, but its tactics will be more
argue that previous efforts to bring China policy measures remains an open issue. It multilateral in nature. Whether this approach
into the global system were fundamentally will clearly entail ‘multilateral jawboning’ but will be more successful than President
misdirected and that Xi’s actions are only the could also include increased coordination Trump’s efforts remains to be seen. But, at a
latest wake-up call. on tariffs, sanctions and policies on Chinese minimum, it will be more consistent with the
The wind was blowing in this direction investment. It may prompt the Biden traditional role of the US as a global leader
even before Donald Trump’s ascent to administration to pursue new (or expanded) and restore a measure of normalcy to US
power, but he effectively tapped into the trade agreements, potentially including economic diplomacy. ♦
‘The US has scope
to work with its
allies to press
China to reform
and open up.’
20 BULLETIN WINTER 2021 OMFIF.ORG
BTN_Q1.21_000_Bulletin.indd 20 29/01/2021 15:32After Covid-19, we require
a new form of finance
As calls from both inside and outside of the sector grow louder, banks need
to play their part in socially-responsible growth, writes Joseph Ding, senior
researcher at China Construction Bank University in New York.
THE Covid-19 pandemic has revealed Data and artificial intelligence technology, 77 built-in inclusive finance use cases, 11m
fissures in the social fabric of economies enable lenders to analyse huge amounts of registered users, 3.6mcertified corporate
developed or developing, big or small. The data from disparate sources, and generate customers, and over RMB250bn in total
financial industry, thanks to its relatively a multi-dimensional profile for proactive credit approvals.
early and broad adoption of technology credit and risk models. These reflect The Yu Nong Tong platform is dedicated
and strengthened balance sheets following customers’ credit-worthiness and risk to the agricultural sector and carries relevant
the 2008 financial crisis, has so far seen characteristics in an accurate and holistic educational content as well as low-cost
relatively few business failures. In fact, manner. credit products for farmers. It operates
many banks have posted healthy profits ‘Hui Dong Ni’ and ‘Yu Nong Tong’ are two nationwide in China and has over RMB2tn in
throughout 2020, even while setting aside such examples from China Construction total loans outstanding.
provisions for future non-performing loans. Bank. The former, meaning ‘Benefit follows The demand for such products and
The stark contrast between exuberant you’, is an inclusive finance mobile app services could not be clearer. The challenge
equity markets and the dire state of that services a diverse group of SMEs now is to build on what has been achieved
the main street economy has brought and retail customers from start-ups to in the Covid crisis. The key to this lies in
a renewed sense of urgency in calls for farmers to those closer to the poverty line. collaboration: industry leaders must work
social responsibility, sustainable growth Key features such as two-way interaction, together to reshape the next generation
and stakeholder capitalism. But it’s not just ‘one-minute’ approval and a 24/7 service of finance, where technology and financial
outside activists who are the leading voices. with complete on-line process and costs inclusion are the recipe for a socially-
Industry leaders such as Bank of America’s transparency, have elevated ‘Hui Dong Ni’ responsible and sustainable path to long-
chairman and chief executive Brian to be an industry-leading platform with term growth. ♦
Moynihan are among the most powerful
advocates for responsible banking.
It is also a global trend. In Asia, leading
financial firms such as China Construction
Bank have laid out a vision of ‘new finance’, ‘Industry leaders
calling for a deeper impact and longer- must work together
term effectiveness of financial inclusion
to reshape the next
to address social inequality and the
misallocation of resources. At the heart
generation of finance,
of this vision lie the democratisation of where technology
digital technology. Fintech and financial and financial inclusion
inclusion become the core long-term growth are the recipe for a
strategies, and are embodied in many
socially-responsible
large-scale inclusive service platforms.
These innovative platforms, implemented
and sustainable path to
with nascent technologies in Cloud, Big long-term growth.’
OMFIF.ORG WINTER
WINTER2021
2021 BULLETIN 21
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