Finance: Research, Policy and Anecdotes

It is hard to concentrate on other issues given the brutal aggression that Putin is unleashing on Ukraine, but CEPR has just published an eBook “Prospects of the Global Economy after Covid-19” with three forward-looking articles on the future of institutions, global cooperation and financial systems that I co-edited with Yung Chul Park from Korea University. The three papers are by Daron Acemoglu, Maurice Obstfeld, and Yung Chul Park and I and are based on presentations at the 30th Anniversary Conference of the Korea Institute of Finance in November 2021 in virtual format.  An introductory Vox column is here.

Daron Acemoglu focuses in his paper on recent trends in income inequality, arguing that the rise in inequality has been driven by globalisation but even more importantly, by new digital technologies such as specialised software and robotics, automating work previously performed by low- and middle-skill workers. These trends have been exacerbated by an increasing focus on corporate profits and weakening of unions, the rise of global big tech firms without the necessary oversight, and capital being taxed less than labour. These trends are intensifying with the rise of artificial intelligence technologies, which are not just continuing the automation trend but have also contributed to the retreat of democracy and steep falls in trust in public institutions (and have allowed for mis-communication campaigns, if I may add, resulting to Brexit, Trump and ultimately Putin’s invasion of Ukraine) . To counter these trends, Acemoglu calls for the rebuilding of domestic and global institutions capable of harnessing the power of large corporations and significantly redirecting technological change.  He also calls for a welfare state 3.0.  As I mentioned in my panel discussion contribution, many of these ideas remind me of Martin Sandbu’s policy agenda in The Economics of Belonging. It certainly calls for a rethinking not only of specific policies and institutions but more broadly the social contract.  

Maurice Obstfeld chronicles the evolution of the global financial markets since the Global Financial Crisis focusing on changes in the markets' domestic impacts, the strains that have emerged due to the COVID-19 crisis, and risks that may lie ahead. He points to a volume of global financial transactions disproportional to any fundamental economic need or activity, yet producing a system prone to fragility, as well as the increasing importance of the Global Financial Cycle. And as monetary policy is being tightened in advanced countries, there are important risks ahead for emerging markets.  He points to four important areas policy reform: expanding the regulatory perimeter to non-bank financial intermediation; extending the scope of bilateral central bank swap lines as part of the global financial safety net; revisiting the use of capital flow measures as part of a larger toolbox to enhance stability in small open economies; and a new architecture of sovereign debt restructuring, which might be needed in the wake of rising sovereign debt burdens in many emerging markets.

Yung Chul Park and I discuss the shorter- and longer-term challenges for the financial sector, both related to the exit from the pandemic and consequent economic crisis and to the challenges posed by economic transformation, digitalisation and climate change. As I have discussed in another occasion, sequencing of exit strategies from government support is important to avoid cliff effects and scarring on the one hand, but also in terms of how quickly the economy can recover and manage the necessary resource reallocation process. Beyond the exit from direct support measures for corporate and financial sectors are the challenges of monetary policy normalisation and fiscal consolidation, with different countries and regions of the world facing different challenges and needs for policy normalisation (and further complicated by Putins’ aggression against Ukraine). Beyond the short-run challenges, the financial system has undergone structural changes over the past decades. Most importantly digitalisation has been an important disruptive force, as we also discuss in this recent ASC report. A final challenge that we discuss is that of climate change, which both poses problems for the financial system and relies on the critical function of the financial system for the necessary resource reallocation. However, tentative evidence has shown that banks might have limited incentives to support such a transition (especially when compared to public capital markets), which puts the focus on the regulatory response to the climate change challenges but also the question of the relative roles of different segments of the financial system.

The debates around these topics reinforce the critical contribution that economists can and should make to the current challenges that humanity as such and advanced, emerging and developing economies face as they exit from the pandemic. This exit poses many challenges for policymakers across the globe but also the opportunity to address fundamental risks for humanity and move towards a safer and more sustainable world. Obviously, the geopolitical tensions following Putin’s aggressions add another important challenge for societies and economies across the globe and will make addressing the already existing challenges not easier.

Overview