Facing crises flexibly instead of withstanding them
Economies can weather crises better if they develop the ability to yield and bounce back, in other words, to respond in an agile and flexible manner rather than simply enduring economic shocks. This dynamic concept of resilience was the core message Markus Brunnermeier wanted to get across in a Policy Web Seminar jointly organized by the Leibniz Institute for Financial Research SAFE and the Center for Financial Studies on 21 September 2021.
“We may have to deal with new pandemics, a new financial crisis, and other imponderables in the future,” said the economist from Princeton University at the beginning of the event. His answer to how these crisis scenarios can best be countered is to make economies and societies more resilient. In this context, he said, the difference between robustness and resilience is essential. “Robustness means withstanding any shock like an oak tree in the wind. In comparison, resilience means rather giving in but being able to bounce back, like a reed that constantly sways in the wind but does not break,” Brunnermeier explained. Just as resilience can differ at the individual, systemic and societal level, there are also risk situations in which it is no longer possible to give way or bounce back. However, these situations must be avoided.
Responding resiliently to crises does not mean avoiding risks per se, Brunnermeier continued. Resilience offers the ability to recover, which in the long term promises a higher average growth rate, even if this results in higher risks in the short term. Therefore, society should focus on innovation and competition, accept occasional setbacks, and consciously expose itself to calculable risks to prepare for shocks. “If you can recover, setbacks matter less,” the economist said. This ability, he said, allows to gradually take more risks, provided an open-minded society.
Regarding politics, Brunnermeier explained that managing crises it is not enough. Resilience means to use available redundancies, for instance in the form of resources or reserve capacities. During the Corona crisis, it was possible to return to a “new normal” through the development and use of vaccines. From a macroeconomic perspective, a low-interest-rate environment, such as the one currently prevailing, offers more fiscal space and thus more fiscal resilience and less monetary resilience, as the risk of a liquidity trap is higher due to the effective lower bound. In finance, efficient debt restructuring to avoid debt overhang in combination with central banks as lenders of last resort is a resilient approach, he said. Capital requirements, on the other hand, functioned more as robust buffers. “In good times, fiscal capacity should be built up, even if it may be politically unattractive,” Brunnermeier said.
Central banks and macroprudential regulation as guarantors of stability
A threat to resilient policy approaches is posed above all by deflation and inflation. To bring this danger under control, he said, it is important to guarantee independent central banks – as in Europe via the EU treaties – and to rely on macroprudential regulation. “A good system is comparable to a racing car, which can be accelerated if at the same time the brakes work reliably,” Brunnermeier said. When inflation rises, central bank intervention and financial stability monitoring can pay off, whereas in times of crisis previously built fiscal capacities can be used. For example, he said, the Fed proved to be a “market maker” in March 2020 during the outbreak of the Corona pandemic, when the U.S. treasury market nearly collapsed. “Now is the time to build the macroprudential buffers,” Brunnermeier concluded.
In the discussion of the presentation, Sir Paul Tucker, a senior fellow at the Harvard Kennedy School, emphasized that the resilience concept Brunnermeier elaborated was enormously versatile and applicable to almost any shock scenario. Tucker, however, focused more on aspects of democratic theory and international relations with an eye toward resilient structures. “Democracies are more resilient than authoritarian regimes,” Tucker said, arguing that in constitutional systems, it is possible to remove a government through elections without calling into question the system of government.
Authoritarian regimes focus on robustness rather than resilience
Using Brunnermeier's example of Fed intervention in the U.S. treasury market at the start of the Corona pandemic, Tucker illustrated that central banks, in this understanding, would certainly contribute to a resilient system that kept markets from collapsing. “But the question is, could the private system have been more resilient so that the central banks had to intervene less during the Corona crisis?” Further, Tucker stressed that geopolitical conditions could lead to trouble in the foreseeable future, especially when it comes to trade agreements. If, for example, two countries were to conclude an agreement that had bad knock-on effects on a third country, there would be the question of external effects that could destroy resilience.
Markus Brunnermeier added in the subsequent Q&A session that authoritarian regimes tend to rely on robustness rather than resilience. The argument about geopolitics is reminiscent of the recently forged alliance between the U.S., the U.K., and Australia, which broke up a multi-billion-dollar submarine supply deal between France and Australia to France's detriment.