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FINANCE | 09.24.2020

“We have to stop the bleeding and avoid a long-term solvency problem”

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Doctors, politicians and society in general have been confronted with an unknown problem, with consequences that are also difficult to foresee.
Economists, too, are seeing how all the macroeconomic and macrofinancial analysis tools that they’ve relied upon to make their calculations so far are not sufficient to be able to measure the potential impact of the current economic crisis. “It’s a textbook economic moment, in which we can no longer count on what happened in the 2008 financial crisis, or the dotcom bubble in the United States in early 2000, or even the crisis of emerging countries,” says Gonzalo de Cadenas-Santiago, Director of Macroeconomics and Financial Analysis at MAPFRE Economics, during an interview with Libertad FM’s radio program Empresa360. According to the expert, it is vital to stop the bleeding in the short-term and promote economic stabilization in the long-term. “We have to prevent a liquidity problem from becoming a long-term solvency problem.”

The current context has forced the US Federal Reserve to change its mandate and demonstrate greater flexibility in the face of inflationary pressures. “For the past 30 years, it has been the main concern among economists, when there was inflation to worry about. I would worry more today because there is no inflation or deflation at a time when we have such high levels of debt — as high as Japan had in the 1990s,” said the economist, who nevertheless recalled that “in the past, it already flirted with the idea of making changes to the monetary policy target, asymmetric inflation targets or the possibility of using nominal GDP as a reference.” He believes it is a change that could be imported into Europe, “but in the short-term, it is in Europe’s best interest to stabilize the economy downward, that is, to prevent a nominal contraction of the economy that could further undermine or exacerbate effects on top of the debt problem.”

This situation could put the European Central Bank (ECB) in a predicament if these inflationary pressures eventually come, “given the asymmetries of growth, income and price context in the north and the south, and of course also due to their nominal and fiscal manifestation.” In fact, the MAPFRE Economics expert explained that we could face an inflation problem in the medium- and long-term, “because of the rigidities of production systems and the sales problems that will result from a prolonged crisis, but also as a result of the massive monetary deluge that was injected in 2008, which had not been absorbed up to now, and which has now become reactive.”

In the specific case of Spain, the Central Bank of Spain has downgraded its growth forecasts and pre-empted an unemployment rate that could exceed 22 percent in the worst case scenario. In this regard, the MAPFRE Economics expert believes that it will depend on the flexibility provided to the economy going forward and the handling of temporary layoffs (ERTEs). “A factor market, such as the labor market, must be made as flexible and dynamic as possible. And that will allow unemployment to level off,” he added.

Despite the significant rise in debt levels, De Cadenas-Santiago recalled that spreads in Spain remain contained, thanks specifically to European support. But he said that it will also depend on how that support ends up being financed. “Europe is going to create a new asset that will become a safe haven, which may lead to a rally in the debt interest rates of some economies.” If this happens, pressure could be taken off the financial system, the margins of which have been eroded as a result of such low rates, but it could also lead to a premium increase for Spain and other peripheral countries.

The economist also offered a brief analysis of the situation in Latin America. “There are ‘several Latin Americas,’ one of which carries very significant weight for Brazil or Mexico, with different dynamics. And then there is a cluster of ‘other Latin Americas’ composed of the Andean countries and the other countries that are smaller in economic terms.” In general, in his view, they all face difficulties because they have limited public support. “In these countries, the lack of resources leads to longer lockdowns and less activity, and this also leads to production system failures. It is difficult for them structurally, but they are also more flexible,” he concluded.