Summary of The Global Economic and Financial System: The Challenge of the Unconventional

 “Whether we like it or not, we have a global economy” said Jacob A. Frenkel, the former Governor of the Bank of Israel as he set the stage for the lecture he delivered on April 20th titled, “The Global Economic and Financial System: The Challenge of the Unconventional.”  This lecture was co-sponsored by the Center on Global Economic Governance and the Program in Economic Policy Management.   

At the outset, Frenkel prefaced his informative and thought-provoking lecture by encouraging those in attendance to rethink the way in which global economic challenges emerge and how we can best address or prevent them. Citing current global economic challenges more generally, he began by noting that compared to his previous lectures: “The subject does not change—what changes are the analysis and the answers because this is a changing world.”

Considering the conventional role of central banks and the goals of monetary policy, Frenkel queried whether or not central banking has changed so fundamentally that “we can throw the old textbook away” or are we to simply “add a new chapter to the old book.”  In agreement with the majority of the audience, Frenkel iterated that he is a firm believer that “you must keep the old book next to you.”

Despite the fact that there are various chapters to consider, Frenkel insisted that we must first look at China. Frenkel noted that there has been a very dramatic decline in the growth rate of emerging economies in Asian countries—in China especially—since the recovery of the financial crisis in 2009.  Matched with this decline in growth, investment in emerging markets more generally has plateaued compared to that of previous years.

Frenkel suggested that the one key measure to look at to determine the health of the global economy is trade.  “China has become a central fixture in the world trading system” he remarked, and given that China’s economy is export-driven, “the rest of the world feels the impact of its decline in growth.”   Although China’s decline in economic growth has been at the expense of developing countries and emerging markets, Frenkel stated that the rest of the world ought to “look at China as an opportunity rather than a threat.”

With a particular focus on the landscape of the global economy in 2009, Frenkel acknowledged that although 2009 is a year the world would like to forget, we must not forget the lessons it has taught us.  Ultimately, according to Frenkel, the world was reminded during the post-financial-crisis’ economic recovery that “if you want to make sure that growth in the world decelerates, close trade.” 

Reinforcing this contention, Frenkel reviewed graphs and collected data that illustrated trade volume in the world shrunk by more than ten percent in 2009 and has since resumed in a very mediocre way.  In the West, Frenkel illuminated the weakening of the real economy on both sides of the Atlantic—especially in the US and Europe’s labor market.  Frenkel thus highlighted that this change was reflected by a significant rise in unemployment in the US and Europe at nearly equal rates.  For the US specifically, we have since seen a decline in the unemployment rate; however, Frenkel, with a general consensus from the lecture attendees, concluded that the US is not yet out of the woods because the US decline in unemployment has not been matched with an increase in output.

After inviting commentary on this conclusion from the audience, attendees cited changes in the labor force participation rate, the proportion of skilled and unskilled labor in the labor force, and a lower aggregate demand as just some of the reasons the unemployment-output mismatch.

Frenkel further emphasized that governments have a number of policy tools at their disposal to address global economic challenges, affirming that central banks are not the only players in the game.  “Monetary policy has somewhat become overburdened” said Frenkel, citing Shinzo Abe’s ‘three arrows’ as plausible mechanisms needed to repair and maintain a healthy economy. 

More commonly referred to as Abenomics, the three arrows include: monetary policy, fiscal policy, and structural policy.  Although Frenkel described structural policy as difficult to implement, he highlighted that “without it, nothing works.”  The main takeaway is that each mechanism must work together to influence the global economic and financial system.

Returning to the role of central banks and how they go about implementing monetary policy, Frenkel recognized that historically, a central bank’s balance sheet listed some of the best quality assets—government bonds and treasury bills to name a few.  With the passage of time, cited Frenkel, “all central banks have increased liquidity in the system” and “total assets of key central banks have increased.”  Frenkel described transferring liquidity to the financial market as a “complex” process.

Frenkel concluded his lecture by asserting that financial markets are “the mirror of the real economy.”  He suggested that after an assessment, if policy makers cannot give the financial market a favorable evaluation, then there is a problem.  “We need to make sure that [financial markets and the real economy] are in correspondence with each other.  Moving forward, we must acknowledge that the economic activity provides us with only a snapshot of the real economy and that financial markets allow policy makers to look into the future.

The presentation slide deck can be viewed and downloaded here.

- Jerrel Baker, MIA '17