As long as things go right, bankers get huge bonuses, and when things go wrong, taxpayers pay

Global inflation is a disease for which the known cure is raising interest rates, which means reducing demand (consumption and investments). Yes, but it is a medicine with three very unpleasant side effects: a negative effect on economic growth (recession), an increase in the budget deficit and instability of the financial system (bank failures).

Medically, I wonder what is good advice?

• Don’t decide on a drug based on side effects because it is definitely essential to recovery!
• Rather, it hurts a lot for a short period of time, but quick intervention is the best antidote.
• Or can the operation be done only after the patient recovers a bit and gains strength?

Budapest Conference

Rock-solid commitment – ​​If the answer had to be summed up in one phrase, this could have been the motto of Corvinus University, the Bank for International Settlements (BIS), the London School of Economics (LSE) and the conference. On March 17, MNP Agustín Carstens from Mexico, CEO of BIS, Ricardo Reis from Portugal, Andres Velasco, one of the star economists of macroeconomics, former Minister of Finance of Chile, Professor at LSE and Christopher Erzek, Vice President consulted here. Director of the International Monetary Fund.

As Elod Tagats, rector of Corvinus, said,

The conference was about the challenges of the financial world, dealing with inflation and the crisis, but the international situation on these topics became so critical that it was doubtful whether high-level leaders would be able to come to Budapest.

Inflation is back

One of the problems with the return of global inflation after 25-30 years is that among today’s decision-makers, corporate managers, finance ministers and central bankers, no one has seen it before, and only a few of them know it. Event from textbooks.

So, at first, everyone believed that inflation was “temporary” and demand and supply did not recover at the same time, which was reduced during the Covid period. It later became clear that inflation was not temporary but was triggered by internal and external shocks. This is partly due to governments (like the US) supporting demand with more money during Covid. It was a good decision, the only incentive, i.e. money, was in the system. To demonstrate this with an example: even if the United States distributes several thousand dollars of “helicopter money” to its citizens, it is not the case that such an amount is returned.

Then came the war on February 24, which also raised prices. This is where the real danger came in: high inflation began to connect with expectations.

Individual or public?

The BIS pointed out how different a low-inflationary environment (global inflation of 2-4 per cent) is to a high price of a product (petrol, butter, oil, leather, coffee, cement, chips) or a high-inflationary environment. Inflation is already rampant, prices are starting to move together, everyone is raising prices, and everyone wants a big raise in wage negotiations.

According to the BIS, global thinking has yet to change much, but inflation figures should be pushed back as hard as possible until this high inflation expectation burns through the system.

Inflation is a disease and an enemy. According to Előd Takats, for the economy to work well, trust is needed, people must dare to do business, believe in the sustainable functioning of the economy, primarily money has value. After all, if there is no such belief, the paper itself is not worth much. If there is not much faith in the stability of the value of money, money can be scattered to the wind like in Venezuela.

Three side effects

Inflation has to be fought and it is very difficult to fight it when it is already high. The particular difficulty of the fight is that there are three very serious and unpleasant side effects. A central bank rate hike has an effect

• For the real economy (to ensure that too much falling demand doesn’t turn into a recession).
• For budget balance (due to weak GDP and high interest costs),
• As well as financial stability, that is why insolvency should also be addressed.

The first of the consequences is a recession, where economic activity slows down as demand declines. The positive side of low consumption and low investment is that there is no demand (the fuel for inflation), but corporate managers and voters will be dissatisfied, less money will be spent on consumption and unemployment will arise.

A second side effect, namely budgetary problems, also stems from slower growth and higher interest burdens associated with interest rate hikes, with the government issuing new government bonds at higher interest rates. According to Előd Takats, this also has positive aspects: high inflation, sales tax increases and inflation “eats” local currency debt, at least reducing the debt to GDP ratio.

Finally, the bank panic

The third harmful side effect is more relevant, and we will look at it in a little more detail. It is about the stability of the financial system. As interest rates rise, uncertainty enters the banking system, and desirable confidence requires financial stability and confidence in the banking system.

High interest rates pose a major risk, as illustrated well by Silicon Valley Bank (SVB). According to Tagats

SVB’s problem was clearly caused by rising interest rates.

What did this bank do? He collected billions of dollars in deposits from startup circles in California. He made a small profit in this. But when interest rates started rising, depositors saw better investment opportunities in the market.

The bank could not raise the interest rate on deposits above what the existing government bonds were earning because it did not want to operate at a loss, after which it would slowly become insolvent. However, the depositors went the other way and withdrew money from the bank.

SVB was forced to sell US government bonds to pay its depositors. But as interest (and yields) rose in the market, the price of these government bonds fell, so he could only sell them at a loss.

The king is naked

At one point, SVB appeared to be a stable, well-capitalized bank, with no need to value its portfolio of government bonds. Had he kept them till the end of the term, they would not have suffered a loss by them. But when his depositors suddenly pulled out due to liquidity, the value of the investment sector revealed that “the king is naked”.

You can blame banking and supervision for the bankruptcy, because it was a serious mistake that could not happen in Europe in this form. Here, banks are constantly subjected to stress tests, where it becomes clear how they will react to additional changes. At the same time, it is maturity mismatched, which means that depositors tie up their money for a short period, they can take a car, and banks lend from it for a long period, so this is the main activity. Banks. In other words, banks do exactly this: they borrow money for a short period of time and deposit it at the best interest rate for the long term.

Former National Savings Bank’s logo was a bee. do you understand A diligent bee collects pollen (forints and pennies), takes it to the hive (bank) and over time it turns into, miraculously, honey or more savings.

There is a problem when the pollen does not turn into honey, but there is no major odor, and this problem threatens to recur elsewhere. According to Előd Takats, such a problem could also arise in Europe if the quality of banks’ loan portfolio deteriorates strongly in a rising interest rate environment.

Ethical issues and Credit Suisse

Then let’s do some discipline! Banking crises continue in the global banking system and citizens’ patience is limited. Banks pay their employees huge bonuses in good times, but when times are bad, central banks, guarantee funds, finance ministers and supervisors come in and bail out the bank with taxpayers’ money, who are often “scoundrels”. Compared to SVB’s leading bankers or Californian clients who fly in private jets anyway, the current debt-ridden people who owe the bank are definitely “slums”.

However, this rescue is necessary on the one hand, because if there is no help and if the “too big to die” bank actually dies, then it is a systemic risk, and everyone knows that it is always cheaper to save the bank. Banking system. However, taxpayers are rightly dissatisfied with the system.

After all, it’s also the story of Credit Suisse, which bled from a thousand badly managed wounds over the past decade. In addition to the management scandals, the big Swiss bank did not make much profit, but paid its bankers a lot of bonuses. Then, before long, the whole of Switzerland worked to save the bankrupt with 50-60 billion euros.

A firm commitment

After the Great Financial Crisis, regulators wanted to make sure that no bank could pull the trigger, forcing all banks to close on a weekend. We now know that it didn’t work, that the mechanism failed. This is a serious uncertainty.

So the situation is not easy, but enormous intellectual and financial skills are at work to ensure that the side effects are not too strong during inflation management.

According to Előd Takats, there is no “free lunch” and firm commitment is absolutely necessary: ​​as long as inflation remains high, strict monetary conditions must be maintained, of course taking into account such side effects as the situation. Financial System, Budget and Real Economy.