Central banks have been a powerful tool to steady the global economy in crises past. Their ability — and willingness — to do so now is constrained. The terrain is tougher and the costs of a rescue are higher.
The price Russia pays for its invasion of Ukraine, not to mention the fate of the global pandemic recovery, depends to a large degree on whether Western monetary authorities deploy their muscle and what they are prepared to sacrifice along the way. Less than a week ago, policy makers in most countries were talking about how fast to withdraw support, not how much would need to be extended. Do officials jettison the fight against the highest inflation in decades? Is there a way to stave off financial upheaval without resorting to Covid-era or post-Lehman responses?
Fears of a funding crisis are multiplying: The dollar surged Monday against almost every peer, with Treasuries rallying alongside gold. The Russian ruble sank as the U.S. and European Union aimed to isolate the country from capital by sanctioning the Bank of Russia. The Biden Administration banned U.S. people and companies from doing business with the Bank of Russia, the Russian National Wealth Fund and the Ministry of Finance. Speculation was high Monday that Western central banks will assemble some kind of backstop for the world, while simultaneously keeping pressure on Moscow.
The critical actor in this aspect of the conflict, notwithstanding the geographic proximity of the euro zone to Putin’s tanks, is the Federal Reserve. For all the talk about U.S. decline and complaints that the initial Western response to Russian aggression lacked teeth, the power of the dollar and the breadth of the Fed's reach make it a potent force for Putin to contend with — should it enter the fray.
For people used to the Fed riding to the rescue, there are sound reasons to expect assistance. At least twice since the turn of the century, the central bank slashed interest rates and extended the supply of dollars to friendly peers to alleviate a crunch. The objective of both prongs was to combat aftershocks from what were perceived as once-in-a-century events: the collapse of Lehman Brothers Holdings Inc. in 2008 and the coronavirus outbreak in 2020. In 1998, when Russia was reeling from a financial meltdown, the Fed cut rates despite a robust U.S. economy. American economic leaders backed the supply of aid to Russia then even after it defaulted on debt.
Circumstances are more challenging now. The U.S. has no desire to aid Russia, so long as the current aggression continues. If its banking system craters and the currency becomes truly untouchable in international markets, don't expect the U.S. Treasury or International Monetary Fund to make soothing noises. In the 1990s, the Cold War appeared to be over, emerging markets were all the rage and inflation was relatively muted. Bill Clinton valued his relationship with Boris Yeltsin. The West thought it had a vital stake in nursing Russia along and rebuilding its commercial health. Backed by the Clinton administration, the IMF had spent the preceding year bailing out South Korea, Indonesia and Thailand. Unlike that trio, Russia had nuclear weapons. Leaving Russia to fend for itself wasn’t considered a serious option.
Fast forward to 2022, and the dynamic is entirely different. On Monday, the Bank of Russia ratcheted up its benchmark rate sharply, to 20% from 9.5%, and slapped some controls on capital. Such dramatic steps historically have been unsustainable and often last-ditch efforts to avoid seeking IMF aid. It’s hard to see assistance forthcoming, even if Russia contemplated seeking it.
There are things the Fed can do to reassure markets today, but they are neither cost-free nor straightforward to communicate. It could expand dollar swap lines — or signal its preparedness to do so. Last deployed to great effect at the start of the pandemic, this safety net helped prevent a public health crisis from becoming an economic catastrophe. The central bank took similar steps in 2008. In both instances, pumping dollars into the world’s financial machinery was consistent with its broader policy thrust. Inflation was under control and officials were easing aggressively. By contrast, the preferred gauge of inflation climbed to 6.1% in January, more than three times its target over time. The pace of price increases is well above the comfort zones of the Bank of England and European Central Bank, as well.
The Fed could make it clear that the swaps were all about financial stability. While true, the difference in the broad economic landscape is stark. America's central bank would then face the question of who would get any expanded swap line. In 2020, they went to countries and financial centers that were allied or partnered with the U.S. No American foe got one. Are the swaps extended to a new group of countries, such as those in Eastern Europe? How might Congress, which the Fed considers its real boss, react?
Cutting rates would be a reversal of epic proportions, given Fed officials have indicated they will begin hiking in March, with some signaling openness to a half-point increase. The best contribution central banks can make right now is to be a force for stability. That suggests a quarter-point step in March and several moves of similar proportion. If the situation in Ukraine is resolved or worsens dramatically, the central bank may have to change tack.
There was no doubt about the necessary course during the pandemic and the global financial crisis — the discussion was all about the means. As hard as that seemed, wartime financing will be tougher still.
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