The Week in Covid-19 and Economic Diplomacy: ‘Buy Buy Baby’

Today, the Economic Diplomacy Initiative is launching a weekly tracker featuring major developments in the global economic response to the COVID-19 crisis. We’ll be taking a look at policies that impact the coordination of international governments and central banks, ongoing commentary and analysis, and asking what these turbulent times mean for economic diplomacy.

We’d love to hear what you think. Send us your comments, and be sure to follow us on Twitter @BelferEDI.

The Highlights

• President Trump’s decision to withdraw the United States from the World Health Organization has drawn both concern over the future of the WHO, and questions about the legality of the withdrawal itself.
• The U.S. Federal Reserve’s efforts to stabilize international dollar funding markets seem to be on the right track, but questions turn now to policies it might consider in the future, including “yield curve control,” to support the global economy.
• The European Union put forward a proposal for a 750 billion euro Recovery Fund, to finance grants to crisis-stricken countries backed by a form of joint European lending. But the proposal still faces resistance among member states.
• Emerging Markets have benefited from the Fed’s actions and a global debt relief program, but funding constraints remain a challenge. Poverty rates have also begun rising for the first time in years alongside a growing hunger crisis.

U.S. Developments

U.S. President Donald Trump’s decision to withdraw the U.S. from the World Health Organization was met with both criticism and questions as to the legality of a withdrawal.

• STAT news compiled concerns expressed by global health experts, including questions over what will happen to the many Americans working at the WHO, and reform efforts pushed through by the United States particularly following the Ebola outbreak.
• At Just Security, Harold Hongju Koh takes a closer look at the legal implications of the U.S. withdrawing from the WHO, and finds that both Congress and public health experts play a critical role in deciding whether or not the U.S. will actually withdraw.
• Representative Will Hurd, a Republican from Texas, writes in a New York Times op-ed that a U.S. withdrawal “will have devastating effects on global health, and it will benefit the Chinese Communist Party.” Hurd relates the responses he received writing to other countries asking for their criticism of the WHO’s response, and details the failings he perceives on the part of China. But he ultimately argues the U.S. will benefit from playing an active reformist role within the WHO rather than abandoning the organization.

The Federal Reserve hasn’t introduced significant new COVID-19 response policies in the past few weeks (see our rundown of Fed policies introduced in the immediate wake of COVID-19). But as the Fed heads into its open market committee meetings on June 9-10, analysts are speculating on whether it will introduce new tools such as negative interest rates or “yield-curve control” to ward off a deeper recession.

• Fed Chairman Jerome Powell, in a wide-ranging virtual conversation with Princeton economics professor Alan Blinder, reiterates the Fed’s reluctance to resort to negative interest rates. Powell cites adverse side-effects and mixed evidence that negative interest rates work. Negative rates may interfere with credit intermediation by eroding bank margins and decreasing their willingness to lend to the broader economy. “It’s not clear to my colleagues and me on the Federal Open Markets Committee that this would be appropriate to deploy here in the United States,” he concludes.
• John Williams, President of the New York Fed, noted earlier that the Fed was considering so-called “yield curve control” as an option to complement forward guidance on interest rates.
  
  Sage Belz and David Wessel at the Brookings Institute break down what exactly yield-curve control might look like for the Fed, and a history of the policy in Japan and, during WWII, the United States. Under the policy, the Fed would set a target interest rate for longer-term securities, such as the one-year Treasury yield, and buy as many bonds as needed to hit its target rate, rather than target quantities under Quantitative Easing.
• Heather Gillers reports in the Wall Street Journal on the growing concern that U.S. cities are facing significant funding shortfalls as a result of the virus, threatening public safety spending, government employment, civic services and pension contributions. 

The Fed’s efforts to stabilize dollar funding in global markets -- expanding dollar swap lines with foreign central banks and the “FIMA” facility which allows foreign central banks without swap lines to obtain dollars using their U.S. Treasury holdings as collateral -- appear to have been successful to date.

• Credit Suisse analyst Zoltan Poszar notes that the Fed’s swap lines and other facilities have successfully lowered dollar funding costs for foreign banks by injecting liquidity into the market. (In March, as investors fled into dollars, it became very expensive for foreign banks to access dollars to fund their ongoing business, a situation similar to the fallout of the 2008 financial crisis.) Although some investors worry that trillions of dollars of new debt issued by the U.S. Treasury could provoke similar market disruptions, Poszar believes the Fed’s readiness to inject additional liquidity if needed will limit the impact.
• Mark Sobel, a former Treasury official and current U.S. Chairman of the Office of Monetary and Financial Institutions Reform, compares currency movements today to the 2008 crisis and finds that major currency pairs are relatively stable.

European Developments

European Commission president Ursula von der Leyen unveiled a plan to raise a 750 billion euro Recovery Fund, following a landmark agreement between France and Germany in May, by providing grants to hardest-hit member states. The proposal represents a significant shift in European fiscal policy on two fronts: the fund would be debt financed jointly by European member states (although not as a ‘eurobond’ per se), and funds would be distributed as grants rather than as loans to crisis-stricken countries. 

The work ahead for European diplomats is to secure buy-in from the so-called “frugal four” -- Austria, Denmark, the Netherlands and Sweden -- who released a counterproposal calling for loans rather than grants.

• Jacob Funk Kirkegaard, of the Peterson Institute for International Economics, provides an overview of how the fund would work, and what it portends for European financial integration. Although funding will technically come through member states’ budget contributions, the European Commission will raise these funds in financial markets. That may pave the way for future joint European debt.
• Martin Wolf, writing in the Financial Times, casts the proposal in the history of Europe’s response to crises, and the pivotal role of German Chancellor Angela Merkel. “Once again, this ever-cautious politician has made a decisive move. The EU is embattled from without and within. Will this proposal be enough to resist these pressures? I hope so. The European idea was a response to destructive nationalism. It has to survive.”
• In Germany, former finance minister and architect of European austerity Wolfgang Schäuble came out in support of the plan for grants, telling the German newspaper Welt am Sonntag that “Germans have an overarching self-interest that Europe gets back on its feet.” His comments reflect a broad shift in support of Angela Merkel’s CDU/CSU parties for the new German policy position.
• The Economist looks ahead to the coming negotiations in the context of Brexit. It finds that without Britain’s support in opposing the policy, the remaining frugal four are weakened in the current negotiations. Furthermore, with pro-EU parties forming coalition partners in national governments in the opposing countries, the frugal four may be more constrained in their ability to negotiate.

Today, the European Central Bank announced it would increase asset purchases by 600 billion euros under its pandemic emergency purchase program (PEPP), bringing the total to 1.35 trillion euros. The bank also extended its timeline until June 2021, and said it would conduct PEPP purchases “until it judges that the coronavirus crisis phase is over.” PEPP is aimed at supporting the 12 trillion euro European economy, and has the effect of holding down borrowing rates for governments such as Spain and Italy. But the ECB’s announcement comes in the shadow of a ruling by the German Constitutional Court throwing into question Germany’s participation in an earlier purchase program.

• ECB President Christine Lagarde said at a press conference following the announcement that the ECB expects European GDP to decrease by 8.7% in 2020, followed by a rebound in 2021 of 5.2%. Nonetheless, she said, the ECB sees the “balance of risks around the baseline projections to the downside.”
• Commenting on the German Constitutional Court’s decision, Lagarde noted that the ECB’s policies had been judged by the ECJ as “in line with our policy mandate.” Lagarde indicated the ECB sees the ruling as a matter for the German government, and is confident that a solution will be found that “will not compromise the ECB’s independence, will not compromise the primacy of European law or the ruling of the European Court of Justice.”
• Daniela Schwartzer, co-lead of the HKS/DGAP Transatlantic Strategy Group, and Shahin Vallee, Senior fellow at the Alfred von Oppenheim Center for European Policy Studies, recently wrote about the German Constitutional Court’s “bombshell” ruling and its long-term implications for the eurozone, including the role of fiscal policy.

Emerging Market Developments

Along with the Fed’s efforts to provide global dollar liquidity, the IMF has launched a range of programs to meet emerging markets funding needs. China, which holds a sizable amount of loans to emerging markets, joined an IMF, World Bank and G20 program to provide debt relief for 77 of the world’s poorest countries. However, only 22 countries have participated in the program to date, and there is growing concern about the ability of emerging markets to combat the crisis, and the world’s ability to help.

• Brad Setser analyzes the state of developing countries and the IMF’s response in Foreign Affairs. While the IMF has a plan to deal with true crises, he says, the world lacks a solution for countries such as Brazil and Indonesia which will not likely need a formal IMF program but will face funding constraints in fighting COVID-19. Setser proposes a IMF Special Drawing Rights allocation, such as the $250 billion allocation in 2009, and a new lending instrument to help countries in their response to the virus.
• Jeremy Mark and Belfer Center Fellow Josh Lipsky scan the path ahead for debt moratoriums and forgiveness for developing countries. While the IMF and World Bank can lead the way, they argue, China will have to play an active role given its increased lending to developing countries.
• At the Bank of International Settlements, Yavuz Arslan, Mathias Drehmann and Boris Hofmann assess local currency bond purchase programs enacted by emerging market central banks to shore up financial markets. “Positive initial market reactions,” the authors write, “suggest that the programmes were successful in restoring investor confidence and did not lead to higher inflation expectations” Hyun Song Shin, head of research at BIS, tweets the key takeaways.
• The Economist points to new issues in rising poverty rates and a growing food crisis. With the World Bank estimating that COVID-19 will erase two years of progress in eradicating poverty, and the World Food Program expecting levels of acute hunger to double this year, policymakers face greater challenges in aiding developing countries.
• Harvard Kennedy School Professor and newly appointed World Bank Chief Economist Carmen Reinhart describes the way COVID-19 is exacerbating what was already a looming food crisis, and warns of the risks of national “food protectionism” further driving up food prices. Rising food prices are regressive, which tends to widen inequality and risk social unrest.

The challenge ahead for policymakers in economic diplomacy, beyond directly supporting emerging markets, is mitigating the possibility of both an economic crisis or a lingering reservoir of COVID-19 in emerging markets that could migrate to the global economy.