New Rules for Finance and the Global Financial Architecture Franklin Allen, Piroska Nagy-Mohácsi, Ricardo Reis and John Gordon As governments and central banks have worked to prop up the economy through fiscal stimuli, the relationship between the two has become blurred. Financial markets are being impacted by scaled-up quantitative easing. And a new international financial architecture is in the making. Central banks are revising their mandates; fiscal authorities are adjusting to constraints and upgrading cooperation with central banks; and the changing global financial architecture reflects both the rising importance of central banks and the gradual encroaching of key institutions on each other’s traditional roles. We propose measures to enhance the credibility of the rapidly changing national institutional arrangements for fiscal and monetary policy and call for identifying and managing the risks from the emerging new global financial system. The pandemic has triggered radical changes in both national policies and the global financial architecture. Fiscal policy has provided large stimuli to prevent major economic depressions, reduce inequalities, and deal with large and rising private debt. Monetary policy has scaled up its support for fiscal policy, with quantitative easing (QE) increasing in size, and purchases that target new market segments. The lines between government and central bank policies have become even more blurred. Central banks like the Federal Reserve, the European Central Bank (ECB) and the People’s Bank of China have expanded their swap and repo lines. Emerging market policies have also changed in radical ways. Due to positive spillovers from advanced country monetary policies and their own improved credibility, emerging market central banks also have been able to conduct QE for the first time, without immediate impact on inflation and the exchange rate. Meanwhile, financial markets have also been reacting to changes in monetary policy, with implications for the monetary transmission mechanism, market structures and ultimately financial stability. Less understood, but critically important, is the interaction between monetary policy and financial market structure, and ultimately financial sector resilience. Central bank swap lines complemented the role of international financial institutions (IFIs), but also blurred the lines between these types of institution – notably with the IMF’s mandate on reserve and exchange rate policies. A new international financial architecture is in the making. Central banks are revising their mandates; fiscal authorities are adjusting to constraints and upgrading cooperation with central banks; and international institutions are caught by the retrenchment of multilateralism. But all this has risks. A lot can go wrong when central banks are monetising debt without apparent limits, when sovereign and corporate debt levels reach historic highs with rising default probabilities, and when superpowers increasingly ignore international organisations. Recommendation 1: Don’t stop stimulus now, but watch out for QE tipping points. QE has played a much-needed role in financing fiscal expansions, and it should be continued to help economies bridge to the post-COVID world. However, monetary and fiscal authorities should watch out for potential QE tipping points – in particular, the risk of inflation, and the capacity of the central bank and the fiscal authority to each service the interest payments on their debts. Continued low interest rates create additional debt service capacity for governments which borrow in their own currency. But risks are higher for corporates and in emerging markets, where governments borrow significantly in foreign exchange. Given the exceptional times,
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