Bryane Michael, University of Oxford and Viktoria Dalko, Hult International Business School
For decades, scholars and policymakers have looked at the central bank as the passive night watch-person of the economy. The US Federal Reserve, Bank of England and the European Central Bank (among others) should provide a stable amount of money for the economy – and thereby stable price levels. They could influence the amount of bills in circulation or interest rates when needed to heat or cool inflation. Yet, trying to bolster economic growth – much less corporate productivity – could only lead to problems.
Since the financial crisis, big name economists have started to question the monetarist orthodoxy of the past 30 years. Robert Hall (a former president of the American Economics Association) and Greg Mankiw (an economic advisor to George Bush Jr.) floated the idea as early as 1994 of nominal targeting. Such targeting would give institutions like the Fed the requirement to balance price stability with output growth. Such an approach targets the nominal, or value on the shelves, of goods and services. By 2017, the former head of the Fed himself recommended such targeting (albeit temporarily). In a world with near zero interest rates, central banks clearly need to do something more than just buying government debt and managing below zero interest rates.
New evidence points to a new role for central banks. In that new role,our new research has found, central banks might influence real economic productivity. By buying local companies’ stocks, bonds, securitized instruments and other securities, central banks could channel funds to companies. Such purchases could help companies, particularly in developing economies with fragmented banking sectors, fund productive projects. In other words, the composition of a bank’s balance sheet could represent an instrument of monetary policy just as much as the amount of debt or liquidity on them.
The art of central bank investing
Countries with four attributes represent prime beneficiaries for these kinds of policies. Namely, countries with near zero interest and inflation rates, dysfunctional banking systems, and with governments less trusted than their central banks. Companies in these places have little recourse to funding, and could significantly benefit from the banking and financial experience of these countries’ central banks. When good ideas meet money, they can buy inputs, technology and the other things needed to raise productivity. Before Milton Friedman started writing, central banks and development banks often had similar roles (and in places like Latin America still have similar mandates).
The effects of central banks purchasing securities on productivity depend on the country. For some countries, central bank purchases of their securities raises productivity. Panama represents the only country where such purchases have the chance of having a larger percentage increase on productivity than the percent increase in such purchases. For 13 other countries– including Senegal, Burkina Faso, Botswana, Venezuela, Namibia, Bangladesh, Paraguay, Ukraine, Macedonia, Mauritius, Japan, Suriname, Haiti – central bank purchases of these securities still positively affect productivity – after removing the effects of other factors like changes in demand, interest rates, exchange rates, better law enforcement and so forth. In others, giving losing companies more money only throws good money after bad. We call such an effect a ‘sloth effect.’ Central bank investments in these countries can encourage sloth, as managers and owners possibly use the money sub optimally, rather than use it for productive investment for their companies.
Without the crisis, we would not have seen much of this data. Central bank law remains hostile to buy private companies securities. Many central banks used emergency provisions in their laws to make these purchases (like the Fed and the European Central Bank). Our random sample of 25 central banks’ laws show that only about one-fifth allow (or allow under very stringent terms) a central bank to purchase private sector securities. If central banks wanted to change their laws though, simply adding a rule won’t work. Central banks need a new post-crisis mentality.
Redesigning central bank law in the post-crisis era
Few central banking laws are in a position to focus on output. Our research shows the extent to which central bank laws around the world encourage private securities purchases, on a scale of 1-6. A score of 1 – which applies to countries including Poland, Ecuador, Malaysia and the Philippines – means the law explicitly does not allow private sector securities purchases. A score of 6 means such purchases appear in the objectives of the central bank – this doesn’t apply to any country. Countries such as Haiti and Iraq score 4, which means investment is an objective somewhere, but they are ambiguous about private purchases. Most central bank laws leave the issue of such purchases ambiguous.They do not allow, nor forbid, such purchases. Such law hardly forms the basis for an output-oriented central bank. How can a central bank focus on raising output, if the bank cannot even engage directly with the companies that make such output?
A nominal output mentality starts with new law. A redesign of central bank law in the post-crisis era starts from the first articles governing the objectives of the bank. Nominal GDP targeting makes the central bank target both price stability and real output growth at the same time. Subsequent articles treat the way the bank deals with these purchases. When they can be made? How? Which companies may participate? Countries unable or unwilling to commit to a complete redesign have other options. Some central bank laws set the bank’s objectives and rules by government decree. In these places, a simple executive decree will suffice. Other places have broader objectives, like promoting a friendly investment environment or to support national interests. Shoehorning private asset purchases into these objectives represents a possible, if less than ideal, option. Other banks give the central bank the competence to act as a lender-of-last-resort. In very dysfunctional markets, a central bank could easily play such a role all year long.
Overcoming financial crises
These results give backing to the large number of economists strongly advocating nominal GDP targeting. They also give the central bank a role to play in fighting to overcome financial crises, and ensuring they do not start in the first place. Not every central bank represents a candidate for such rules. Yet, these data show that such purchases can help some countries’ firms grow. These data also show where such purchases will not work. Central bank laws trying to capture these gains need more than simple amendment. The past crisis represents a good opportunity to rethink central bank regulation. Now, it’s up to businessmen to make their case to their leaders.
Seven lessons from 2020
Rebeca Ehrnrooth, Equilibrium Capital and CEMS Alumni Association President
Attending a New Year’s luncheon on 31 December 2019, we played a game that involved predicting the world in 2020. Some of the questions included: would Uber become profitable? Would the three-decade bond rally finally come to an end? Would the US hit a recession?
Unlike any of our predictions based on a traditional approach to business and predicting, we now know that 2020 became the year where business, professional and personal plans were turned upside down, reshaped and put-on hold. The proverbial black swan had arrived.
As revealed in a new CEMS Guide to Leadership in a Post-COVID-19 World, to which I contributed, the COVID-19 pandemic has exposed deficiencies in the 20th Century vision of leadership, giving a rare opportunity to question the status quo.
So, what are the main lessons from 2020?
- Humans are enormously adaptive. This is not an extinction scenario. The world is getting used to dealing with global human disaster which may become a recurring event. Life continues guided by new parameters.
- No sector or country is immune to rapid change. Just as the leveraged finance and equity markets ground to a halt during the Global Financial Crisis, we have seen a disruption in the financial markets (including M&A) in 2020, including a significant redistribution of wealth between sectors; think tech vs airlines and the hospitality industry. When a market is disrupted it has secondary and tertiary effects such as less work for accountants, lawyers, financiers etc.
- Location is not as important anymore. The belief that finance staff need to be based in one of the financial capitals to be effective has been forever altered. Pursuing a career in finance from anywhere is becoming possible. However, it’s likely that over time, financial controls and human interaction will move the work model back towards the traditional office approach, as work is a critical sanctuary for people. While working from home may allow more time for family, chores and sports, it is mainly effective for people who already have their internal and external networks. For junior employees it presents a notable challenge as they may be forced to spend their formative years without a chance to really build their networks.
- Change is likely to be lasting. The opportunity for alternative finance and tech focused providers is enormous and 2020 will accelerate this shift. For example, many retail banks are providing rather poor customer service, blaming the pandemic. Even the most loyal customers will be heading elsewhere. For recent graduates and current students this is a major shift; future winners and key employers may not be names we are used to seeing in the headlines.
- There will be a spotlight on leaders with visionary strategy and understanding of the operations. 2020 showed many politicians and business leaders behaving like they were playing a game of snakes and ladders, rather than executing a thought-out strategy. The next wave of thoughtful leadership is urgently required.
- Collaboration leads to success. The definition of a pandemic is an infectious disease prevalent worldwide. A global problem requires a collaborative solution rather than each country and industry on their own. Quoting Steven Riley, professor of infectious disease dynamics at Imperial College London: “Once you have the knowledge and you share the knowledge, then you are able to take measures to push transmission much lower”. This principle is transferable to management education. In a world more complex than ever, investing in a degree is hard currency. Combined with the full global alumni network, corporate partners and schools, CEMS is capital that doesn’t depreciate.
- Resilience has become a watch word. Saint-Exupéry’s quote resonates with me: “If you want to build a ship, don’t drum up people to collect wood and don’t assign them tasks and work, but rather teach them to long for the endless immensity of the sea.” We are in a new paradigm – so prepare for the next change. For COVID-19, while we hope that the vaccine will soon upon us, the broader long-term positive challenge remains.
Data after Brexit: How does the end of the transition affect GDPR?
By John Flynn, Principal Security Consultant at Conosco
The UK has officially left the European Union now that the transition period has ended on January 1st 2021. But this could raise issues with one of the biggest bugbears for many companies – the international transfer of personal data.
Businesses can relax, somewhat – GDPR, which took businesses months to get their heads around, is not being replaced. It will continue as the UK GDPR 2018, and will still be based on the criteria of the Data Protection Act of 2018. However, the UK will retain the right to change the UK GDPR as it sees fit in the future.
The main changes apply to those who receive data coming into the UK from Europe. Transfers from the UK to other countries can continue under existing arrangements.
We know it can be difficult to cut through the legal jargon, so we have simplified what you need to know to protect yourself and your data:
1 – Update your privacy notice
Most businesses do not have the correct clauses in place ahead of January 1st, potentially exposing their liability, should something happen to their data. All company privacy notices online will need to be updated to specifically state ‘UK GDPR’, as opposed to ‘EU GDPR’. You will also need standard contractual clauses in place, which cover both parties – those transferring and those receiving the data.
The Information Commissioner’s Office (ICO) has a list of what needs to be included in the standard contractual clause here. The ICO will remain the UK regulator for data protection, regularly liaising with each EU member state.
This also applies to Multi Corporate Groups who operate in multiple countries, who need to update their documentation and privacy notice to expressly cover the data transfers. The UK has applied for an adequacy assessment, which would negate the need for contractual clauses, however this has not yet been approved by the EU.
2 – Data privacy assessments
Any company which runs applications and software should always perform a Data Privacy Impact Assessment. This was also in the guidelines before, but these assessments are now more important for those who outsource their IT operations internationally.
For example, when using a service such as a cloud-based system, the company must be sure that its service provider adheres to UK GDPR and stores the data within the European Economic Area (EEA), or has a binding corporate agreement with the company, where data is stored outside of the EEA. You should also, as mentioned above, make sure that a contractual clause is in place.
3 – Review local legislation
Contracts should now have contractual clauses that specify the responsibilities of the data controller and the data processor. If you are receiving personal data from a country territory or sector covered by a European Commission adequacy decision, the sender of the data will need to consider how to comply with its local laws on international transfers. You should check local legislation and guidance in this case.
4 – Cyber Security health check
The ICO is increasing its capacity and efforts to crack down on data breaches, post-Brexit. Now is a great time for all companies to have a health check to understand their Information Security posture and GDPR compliance. Nobody wants to be caught handling data improperly and fined when it could have been prevented with education and training.
A gap analysis performed by an expert is money well-spent. It’s also a fact that companies that have cybersecurity and Information Security controls are not only able to better defend against attacks but are also far better placed to recover from an attack.
It’s important that all businesses – large and small – are properly preparing their data storage and transferring for the 1st January. ICO has been busy setting examples by fining large, high-profile companies for failing to keep millions of customers’ personal data safe.
It will continue to come down hard on the data breaches of personal identifiable information and special categories of data. The saying ‘prevention is better than a cure’ rings truer than ever this year, and you will thank yourself if you make the efforts to properly store your data now, and not when it’s too late.
2020 reflections and 2021 outlook
By John Hunter, Head of Banking and Fiduciaries, Finance Isle of Man
Reflections on the most surreal year
The Covid-19 pandemic has completely changed the world as we knew it, resulting in catastrophic loss of life and fears of a downturn hang over global economies like a sword of Damocles. In the UK, the new strain has further exacerbated the situation. As I am sure many have already said we are living in what could be called the most surreal times. People have been trying to cope with this “new normal”, by changing their lifestyles and evolving behaviours.
The Isle of Man responded swiftly to the pandemic by closing its borders and enforcing social restrictions which everyone respected and adhered to. Socially and culturally the Island demonstrated all the good things that come from living on a relatively small Island where community still means so much.
The Isle of Man’s financial services sector adapted quickly, seamlessly transitioning to working from home. The banks too adopted flexible remote working practices and continued to support clients around the world helping them navigate the challenging situation and making the most of any opportunities that arose.
Although there is no substitute for face-to-face interactions, we all embraced web-conferencing platforms like Microsoft Teams and Zoom to stay connected with contacts around the world and build and nurture business relationships, whether it was with financial services firms or high net worth individuals looking to relocate to the Island.
Furthermore, a priority for the Isle of Man has been to reinvigorate the business and cultural ties with South Africa. In a normal world, we would have travelled to the country, held in-person meetings with businesses and industry representatives and talked about building on our wonderful historic ties. However, because of the scale and breadth of disruption we had to change all our plans! We hosted a virtual roadshow which comprised a series of webinars exploring why it has never been more important for South African businesses and individuals to choose the right jurisdiction for long term financial planning.
Looking ahead to the future
We are all hoping that the global rollout of vaccines will provide the pathway to some form of return to normality and all the things people are missing will be back. Like amidst all periods of immense turmoil, interesting, new possibilities have emerged such as the revolution in work culture and a renewed importance of being close to nature and green spaces is. And these possibilities can help reshape society for the better.
The global economic recovery and rebuild might seem further away in the current environment especially amidst the new lockdowns. But we are confident in the resilience of economies and are hopeful that different industrial sectors and governments working together would result in green shoots.
The financial services industry has an important role to play in getting the world economy back on its feet. It is a core component of the solution to continue facilitating the financing of corporates, as well as to develop sustainable finance and nurture digital technologies which have proven to be vital during the pandemic. The sector should continue its cooperation and collaboration with governments and regulators to ensure efficient capital flows and financial stability for businesses and individuals.
Banks too have a crucial role to play as they are instrumental to the effective transmission of monetary policies and stimulus packages. As mentioned in a report by EY: “Financial insecurity in the wake of COVID-19 will require banks to boost consumer confidence and help build a more resilient working world.”
We expect the Isle of Man’s financial services sector and banks to continue navigating the situation with resilience as they have been doing thus far and contributing to the global recovery process. Also, we truly hope this will be our busiest year ever (subject to our ability to travel), with an extensive global schedule of planned activity to promote the Island as an international financial centre of excellence and innovation. Personally, I had planned to be in South Africa for the British & Irish Lions tour, but regrettably, it might not take place and as such we will look forward to catching up with friends there as and when we can.
No doubt, there are significant challenges for the world ahead but as Albert Einstein said: “in the midst of every crisis lies great opportunity”. And it is this opportunity that we all need to work together to identify and make the most of. We are confident that in 2021 the Isle of Man will continue to support financial services businesses help their clients, employees, and the wider society through these surreal times. We are all in this together.
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