The Bank for International Settlements (BIS) sees central banks as playing a key role in combatting the COVID-19 pandemic. “Central banks reacted swiftly and forcefully, preventing firms and households from being further burdened by a financial collapse by stabilising the financial system and supporting credit flows,” said Agustín Carstens, General Manager of the BIS, at the report’s presentation. It is expected that the life support measures during the first phase will lay the foundation for a rapid recovery. However, despite these measures, uncertainty may hold back aggregate demand and the pace of recovery.

A greater economic slump than the 2008 financial crisis

According to the BIS report, the halt in global economic activity has been extraordinarily abrupt. The economic collapse was even steeper than during the Great Depression of 1929 and more extensive than that caused by the 2008 financial crisis. Many economies shrank by 25 to 40% in a single quarter and unemployment soared within a couple of months, the report states. Unlike the 2008 financial crisis, the current crisis has spread to all countries of the world and did not originate in the financial industry. Rather, it was a policy-induced recession. Prompted by a public health emergency and in order to save lives, economic activity has been repressed by policymakers implementing lockdown measures. Non-financial corporations were the first to be hit by the crisis and had to absorb the full brunt of the blow. BIS experts write in the Annual Report that “the real economy has sustained immense damage.” 

Central banks’ response

“Together with financial and prudential authorities, central banks have played a key role in the concerted response to the COVID-19 crisis,” the report states. The initial interest rate cuts had only a “limited” soothing effect. “The impact was much larger once central banks started supplying badly needed liquidity and addressing dysfunctional markets,” the BIS experts write.

The BIS believes that the use of prudential tools has been a key part of the measures taken by central banks. In order to sustain credit to households and firms, capital and liquidity requirements have been eased temporarily and have encouraged banks to make free use of capital buffers. “In a remarkable development, prudential policy has been crucial in helping to sustain lending to the economy and preventing banks from deleveraging,” said Claudio Borio, Head of the Monetary and Economic Department at the BIS. After ensuring that businesses have sufficient means of payment to continue their operations, the next stage of the crisis should focus on their solvency, i.e. their long-term viability. “Debt restructuring will be required as resources shift from shrinking to growing sectors,” the BIS reports.

Central banks not sole engine of growth

The report states that the strength of the recovery will depend on how the outbreak evolves and how much economic damage it leaves in its wake. According to Carstens, some of the challenges extend beyond the mandate of central banks: “Monetary policy alone cannot be the engine of growth. A premium needs to be put on keeping fiscal policy on a sustainable path through timely consolidation.”