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In the next downturn, who will call the shots?

Global views and trends

BNP Paribas Asset Management

A “Great Instability” has followed the Great Financial Crisis and the risk of radical disruptive change looks high, with potentially profound implications for investors

  • Central bankers were volunteered to take control of handling the crisis
  • Fiscal policy opted for the backseat, kicking fiscal consolidation down the road
  • A squeeze on living standards led to public ire and central bankers were easy scapegoats
  • Radical changes loom – everything has to change for things to stay the same


The Great Financial Crisis of 2007/08 caused a wrench in how an economic setback is handled, leaving markets and investors in the hands of central bankers, and setting off a debate about who should be in charge when the next recession comes round.

Sir Paul Tucker, Fellow at the Harvard Kennedy School and chair of the Systemic Risk Council, calls for elected officials to step up to the plate in this video recorded at BNP Paribas Asset Management’s Investment Forum [1].

Sir Paul Tucker BNP Paribas Investment Forum

In that sense, disruptive change – the theme of much of the early years of this century as well as the Investment Forum – has stretched beyond obvious areas such as technology and telecommunications into the business of monetary and fiscal policy, and even politics.

When it came to manning the pumps as the Great Financial Crisis unfolded, the task ended up in the hands of central bankers, who felt they had little choice but to dig deeper in their toolkits than they were used to doing and impose what became known as unconventional measures.

The debate still rages over whether they were successful or have merely postponed the day of reckoning. At a time when ‘normalisation’ is far from complete , fears of recession after a decade of sub-par economic growth raise the question of with which policymakers the buck now stops.


The end of stability. Now what?

The Great Financial Crisis came at a time when central bankers were pointing to stable economic growth and stable inflation and were extolling their ability to smooth bumps in the business cycle and hiccups in inflation with monetary policy tools – basically, steering the economy with shifts in interest-rate levels. Their framework – with their independence from policymakers and politics as a cornerstone – was held responsible for a structural improvement in economic stability.

At the same time, a general “loosening of the reins”, as flows of goods, services, labour and capital became global, economic liberalism replaced industrial policy and regulation, and self-regulation took over from supervision, encouraged policymakers to adopt a hands-off attitude, happy to leave the key levers of economic policy in the hands of central bankers, essentially unelected officials.

When it came to handling a full-blown global financial crisis, elected officials – read, the finance ministers – balked at “spending their way” out of the downturn. Instead they passed the parcel to central bankers, mandating them with the heavy lifting and effectively forcing them to adopt unconventional measures once the potential for conventional interest-rate cuts had been exhausted.


Limited scope for another bail-out by central banks

As Sir Paul points out in this video, with interest rates either still at rock-bottom (in the eurozone) or only a few percentage points above zero, economies “are not going to be able to rely on the central banks as much as last time” in the next recession.

Scope for cutting interest rates is limited. In addition, they still hold financial assets – mainly bonds – bought in the markets for cash in the wake of the last crisis as they sought to put a floor under asset markets and provide liquidity. In other words, they are now constrained.


Should unelected officials be making decisions about asset purchases ?

Those asset purchases did not necessarily earn central bankers credit in all quarters. Unconventional policy measures brought monetary authorities into the political arena.

Purchases by central banks of government bonds, was seen by some as central banks financing government budget deficits, blurring the line between monetary and fiscal policymaking. By jumping into the breach, central banks arguably enabled governments to avoid much-needed reforms or the implementation of the measures a government typically takes in a crisis (e.g., tax cuts or higher infrastructure spending).

In addition, the large-scale liquidity injections by central banks favoured asset owners. Main Street did not benefit directly hence central banks were cast as agents of rising financial inequality.


A poisoned chalice: responsibility for handling the crisis

Ill-feeling arose as the public felt it had been left to pay the price for the crisis – increased unemployment, reduced job security, static wages and pensions, savings rates close to zero… in short, a squeeze on living standards. While the pain was felt at the ballot box, with parties at centre losing ground to left and right-wing parties further out on the political spectrum, the perception of central bankers also shifted in the aftermath of the crisis.

Their actions triggered concerns over whether the handling of the next crisis should be left in the hands of officials who are appointed rather than elected and cannot be voted out of office. A fragile truce now exists between central bankers, and their extended post-crisis powers and responsibilities, and the politicians to whom they are ultimately accountable, who in turn face disgruntled electorates.


Procrastination: it will not pay again

Both appear to have little room left to manoeuvre. The central banker’s arsenal looks somewhat depleted at this point, while the politicians will ultimately still have to deal with un-tackled issues such as high and possibly unsustainable government debt, (greater) inequality, changes to the tax and benefit systems and unfair trade practices.

That list of open and potentially radical and disruptive issues, and the risk to political capital that they represent, may tempt politicians to leave the burden of crisis management with central bankers.

Sir Paul would disagree: “We need to rely less on unelected central bankers and regulators and more, as we used to, on elected policymakers. The face of getting us out of the Great Depression was (US) President Roosevelt. Somehow (in the Great Financial Crisis), the elected politicians have been less visible, less upfront. We need more of that.”

[1] For more Investment Forum videos, click here >


This article appeared in The Intelligence Report – 26 February 2019

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