## 11. Actual and Projected Inflation and Real GDP Growth in the U.S. and Eurozone

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### I. Introduction — context and central arguments
- At the onset of the COVID-19 pandemic in March 2020, global stock markets plunged and borrowing costs soared, yet the global financial system remained stable.
- Core argument: policy responses during the pandemic, together with strong pre-existing policy frameworks, contained the financial fallout but also produced unintended consequences that require policy action to strengthen future resilience.

### II. Market turmoil at the onset of the pandemic
- Equity markets:
  - S&P 500 index fell 34 percent from its mid-February peak in just over a month.
- Corporate and credit markets:
  - Funding conditions deteriorated sharply with spreads widening on high-yield bonds, leveraged loans, and investment grade bonds.
- Short-term funding stress:
  - Prime money market funds (MMFs) reduced commercial paper holdings, contributing to a “dash-for-cash” and severe strain on dealer intermediation.
- U.S. Treasury liquidity:
  - Bid-ask spreads widened and market depth declined to levels observed during the global financial crisis.
- Cross-border effects:
  - Dislocations in U.S. dollar money markets reverberated globally, tightening offshore dollar funding conditions and generating stress in other economies.
- Pre-existing vulnerabilities:
  - Nonfinancial corporate sector debt increased to about 90 percent of GDP at end-2019, alongside stretched equity valuations and weaker credit quality.

### III. Policy response and rapid market rebound
- Central bank actions:
  - Major central banks cut policy rates, introduced new asset purchase programs, and deployed liquidity facilities and emergency credit lines.
- Scale of intervention:
  - Aggregate assets of major central banks increased by about US$6 trillion in just under three months since the beginning of the pandemic—more than double the increase seen during the two years following the global financial crisis.
- Fed action:
  - U.S. Federal Reserve announced US$2.3 trillion in credit facilities on March 23, 2020; risk asset prices began to rebound around that announcement.
- Swap lines:
  - Fed enhanced swap lines with Bank of Canada, Bank of England, Bank of Japan, European Central Bank, Swiss National Bank and established new temporary swap lines with Australia, Brazil, Denmark, Korea, Mexico, New Zealand, Norway, Singapore, Sweden.
- Market outcomes:
  - By mid-August 2020 the S&P 500 was trading at the pre-pandemic peak—the sharpest recovery on record after major stock market collapses.
  - Portfolio flows to EMDEs resumed in Q2 2020 and surged to pre-pandemic levels by end-2020, with differentiation toward stronger-fundamentals economies.

### IV. Supporting pre-crisis frameworks and buffers
- Banking sector resilience:
  - Tier 1 capital ratio for advanced economies: about 18 percent in 2019 versus 10 percent in 2007.
  - Tier 1 capital ratio for EMDEs: improved from about 15 percent in 2007 to 16 percent in 2019.
- Policy credibility:
  - Central banks with pre-pandemic track records of meeting inflation targets could deploy unconventional measures and provide prolonged support.
- External buffers:
  - Many emerging markets held sizeable foreign exchange reserves in 2019—often higher than their stocks before the global financial crisis—permitting intervention to limit sharp currency depreciations and dampen financial stability risks.

### V. Unintended consequences and evolving vulnerabilities
- Intertemporal trade-off:
  - Prolonged accommodative monetary policy and large liquidity provision boosted investor risk appetite, encouraging excessive risk-taking and asset price misalignments.
  - U.S. equity rally: S&P 500 rose by over 100 percent from the Fed’s March 23, 2020 corporate credit facilities announcement until end-2021.
  - Nonfinancial corporate debt and housing: corporate bond issuance soared and housing prices surged globally amid low mortgage rates and high demand.
- Inflation dynamics:
  - Inflation fell at the onset of the pandemic but rose sharply in 2021 as economies reopened; in the U.S., year-on-year inflation rate was close to 5 percent in Q2 2021.
  - Fed response: maintained near-zero policy rate through most of 2021 despite inflation pressures, shifted stance in December 2021 as yearly inflation approached 7 percent—the highest level in the last forty years.
  - Central bank framework changes:
    - Fed adopted flexible average inflation targeting (aiming for inflation to average 2 percent over time).
    - ECB revised framework to define inflation objective as 2 percent over the medium term.
  - Risk: not reacting to broad-based and persistent inflation amid uncertainty risks entrenched inflation and de-anchoring of expectations, potentially requiring aggressive tightening with high economic costs.
- Cross-border spillovers:
  - Ultra-loose advanced-economy monetary policy encouraged large, often short-term, capital flows to EMDEs, creating vulnerabilities (leveraging, currency appreciation, asset price increases).
  - Since end-2021, portfolio flows reversed sharply from EMDEs after Fed announced acceleration of normalization, with yields and sovereign risk premia rising—especially for EMDEs with weaker fundamentals.
- Risk migration to nonbank sector:
  - Regulatory tightening of banks after the global financial crisis contributed to intermediation migration to NBFIs.
  - Open-ended funds holding illiquid assets amplified the March 2020 stress through forced asset sales and redemption-driven liquidity spirals; stress subsided only after central bank asset purchase commitments.
  - Growth of decentralized finance (DeFi) and crypto-based intermediation raises unregulated market, liquidity, and cyber risks.

### VI. Key policy lessons and priorities
- Mitigating intertemporal policy trade-offs:
  - Proactively monitor financial vulnerabilities and risk-taking.
  - Develop and deploy adequate macroprudential tools that apply to both banks and nonbank financial institutions.
- Ensuring robust monetary policy frameworks:
  - Central banks must be resolute in tackling inflationary pressures to preserve credibility and price stability.
  - Reflect on strategies to assess when to react to persistent supply-side shocks and when allowing temporary overheating is appropriate.
- Managing capital flow volatility:
  - EMDEs should use macroeconomic, prudential policies, foreign exchange intervention, and capital controls as appropriate.
  - Maintain strong macroeconomic policy frameworks and external buffers in normal times.
  - Multilateral cooperation is needed to strengthen the global financial safety net, including expansion of bilateral swap lines and regional financing arrangements.
- Addressing systemic risks in nonbank financial intermediation:
  - Better understand and address systemic risks posed by NBFIs, particularly open-ended investment funds holding illiquid assets.
  - Implement appropriate liquidity management tools and strengthen regulation and supervision proportionate to the financial stability risks posed.

*IMF Working Paper — Macro-Financial Stability in the COVID-19 Crisis: Some Reflections*

### References .............................................................................................................

### References

### Figures

- 1. Asset Market Performance during the COVID-19 Pandemic .......................................................................... 16
- 2. Portfolio Flows and Financial Conditions in Emerging Market and Developing Economies ........................... 16
- 3. Central Bank Asset Purchases during COVID-19 Pandemic .......................................................................... 16
- 4. Central Bank Policy Interventions and Rebound in Asset Prices .................................................................... 17
- 5. EMDE Portfolio Flows and Sovereign Credit Spreads .................................................................................... 17
- 6. Banking Sector Soundness in Advanced Economies and EMDEs ................................................................. 17
- 7. Policy Credibility and Monetary Policy Response during the COVID-19 Pandemic ....................................... 18
- 8. External Buffers and Currency Depreciation in Emerging Markets during the COVID-19 Pandemic ............. 18
- 9. Financial Vulnerabilities during the COVID-19 Pandemic ............................................................................... 18
- 10. Inflation and Policy Rate during the COVID-19 Pandemic ............................................................................ 19

*Source: wpiea2022251-print-pdf - References*

### 11. Actual and Projected Inflation and Real GDP Growth in the U.S. and Eurozone ........................................

### 11. Actual and Projected Inflation and Real GDP Growth in the U.S. and Eurozone

### I. Introduction — context and central arguments
- At the onset of the COVID-19 pandemic in March 2020, global stock markets plunged and borrowing costs soared, yet the global financial system remained stable.
- Core argument: policy responses during the pandemic, together with strong pre-existing policy frameworks, contained the financial fallout but also produced unintended consequences that require policy action to strengthen future resilience.

### II. Market turmoil at the onset of the pandemic
- Equity markets: S&P 500 index fell 34 percent from its mid-February peak in just over a month.
- Corporate and credit markets: funding conditions deteriorated sharply with spreads widening on high-yield bonds, leveraged loans, and investment grade bonds.
- Short-term funding stress: prime money market funds (MMFs) reduced commercial paper holdings, contributing to a “dash-for-cash” and severe strain on dealer intermediation.
- U.S. Treasury liquidity: bid-ask spreads widened and market depth declined to levels observed during the global financial crisis.
- Cross-border effects: dislocations in U.S. dollar money markets reverberated globally, tightening offshore dollar funding conditions and generating stress in other economies.
- Pre-existing vulnerabilities: nonfinancial corporate sector debt increased to about 90 percent of GDP at end-2019, alongside stretched equity valuations and weaker credit quality.

### III. Policy response and rapid market rebound
- Central bank actions: major central banks cut policy rates, introduced new asset purchase programs, and deployed liquidity facilities and emergency credit lines.
- Scale of intervention: aggregate assets of major central banks increased by about US$6 trillion in just under three months since the beginning of the pandemic—more than double the increase seen during the two years following the global financial crisis.
- Fed action: U.S. Federal Reserve announced US$2.3 trillion in credit facilities on March 23, 2020; risk asset prices began to rebound around that announcement.
- Swap lines: Fed enhanced swap lines with Bank of Canada, Bank of England, Bank of Japan, European Central Bank, Swiss National Bank and established new temporary swap lines with Australia, Brazil, Denmark, Korea, Mexico, New Zealand, Norway, Singapore, Sweden.
- Market outcomes: by mid-August 2020 the S&P 500 was trading at the pre-pandemic peak—the sharpest recovery on record after major stock market collapses. Portfolio flows to EMDEs resumed in Q2 2020 and surged to pre-pandemic levels by end-2020, with differentiation toward stronger-fundamentals economies.

### IV. Supporting pre-crisis frameworks and buffers
- Banking sector resilience:
  - Tier 1 capital ratio for advanced economies: about 18 percent in 2019 versus 10 percent in 2007.
  - Tier 1 capital ratio for EMDEs: improved from about 15 percent in 2007 to 16 percent in 2019.
- Policy credibility: central banks with pre-pandemic track records of meeting inflation targets could deploy unconventional measures and provide prolonged support.
- External buffers: many emerging markets held sizeable foreign exchange reserves in 2019—often higher than their stocks before the global financial crisis—permitting intervention to limit sharp currency depreciations and dampen financial stability risks.

### V. Unintended consequences and evolving vulnerabilities
- Intertemporal trade-off:
  - Prolonged accommodative monetary policy and large liquidity provision boosted investor risk appetite, encouraging excessive risk-taking and asset price misalignments.
  - U.S. equity rally: S&P 500 rose by over 100 percent from the Fed’s March 23, 2020 corporate credit facilities announcement until end-2021.
  - Nonfinancial corporate debt and housing: corporate bond issuance soared and housing prices surged globally amid low mortgage rates and high demand.
- Inflation dynamics:
  - Inflation fell at the onset of the pandemic but rose sharply in 2021 as economies reopened; in the U.S., year-on-year inflation rate was close to 5 percent in Q2 2021.
  - Fed response: maintained near-zero policy rate through most of 2021 despite inflation pressures, shifted stance in December 2021 as yearly inflation approached 7 percent—the highest level in the last forty years.
  - Central bank framework changes: Fed adopted flexible average inflation targeting (aiming for inflation to average 2 percent over time); ECB revised framework to define inflation objective as 2 percent over the medium term.
  - Risk: not reacting to broad-based and persistent inflation amid uncertainty risks entrenched inflation and de-anchoring of expectations, potentially requiring aggressive tightening with high economic costs.
- Cross-border spillovers:
  - Ultra-loose advanced-economy monetary policy encouraged large, often short-term, capital flows to EMDEs, creating vulnerabilities (leveraging, currency appreciation, asset price increases).
  - Since end-2021, portfolio flows reversed sharply from EMDEs after Fed announced acceleration of normalization, with yields and sovereign risk premia rising—especially for EMDEs with weaker fundamentals.
- Risk migration to nonbank sector:
  - Regulatory tightening of banks after the global financial crisis contributed to intermediation migration to NBFIs.
  - Open-ended funds holding illiquid assets amplified the March 2020 stress through forced asset sales and redemption-driven liquidity spirals; stress subsided only after central bank asset purchase commitments.
  - Growth of decentralized finance (DeFi) and crypto-based intermediation raises unregulated market, liquidity, and cyber risks.

### VI. Key policy lessons and priorities
- Mitigating intertemporal policy trade-offs:
  - Proactively monitor financial vulnerabilities and risk-taking.
  - Develop and deploy adequate macroprudential tools that apply to both banks and nonbank financial institutions.
- Ensuring robust monetary policy frameworks:
  - Central banks must be resolute in tackling inflationary pressures to preserve credibility and price stability.
  - Reflect on strategies to assess when to react to persistent supply-side shocks and when allowing temporary overheating is appropriate.
- Managing capital flow volatility:
  - EMDEs should use macroeconomic, prudential policies, foreign exchange intervention, and capital controls as appropriate.
  - Maintain strong macroeconomic policy frameworks and external buffers in normal times.
  - Multilateral cooperation is needed to strengthen the global financial safety net, including expansion of bilateral swap lines and regional financing arrangements.
- Addressing systemic risks in nonbank financial intermediation:
  - Better understand and address systemic risks posed by NBFIs, particularly open-ended investment funds holding illiquid assets.
  - Implement appropriate liquidity management tools and strengthen regulation and supervision proportionate to the financial stability risks posed.

*IMF Working Paper — Macro-Financial Stability in the COVID-19 Crisis: Some Reflections*

### References

### wpiea2022251-print-pdf - References

### Banking regulation, capital buffers, and bank lending
- Abad, José, and Antonio I. Garcia Pascual. 2022. “Usability of Bank Capital Buffers: The Role of Market Expectations.” IMF Working Paper 2022/021.
- Awad, Rachid, Caio Ferreira, Aldona Jociene, and Luc Riedweg. 2020. “Restriction of Banks’ Capital Distribution during the COVID-19 Pandemic (Dividends, Share Buybacks, and Bonuses).” Monetary and Capital Markets Department Special Series on COVID-19.
- Altavilla, Carlo, Francesca Barbiero, Miguel Boucinha, and Lorenzo Burlon. 2020. “The Great Lockdown: Pandemic Response Policies and Bank Lending Conditions.” Working Paper Series 2465, European Central Bank.
- Casanova, Catherine, Bryan Hardy, and Mert Onen. 2021. “Covid-19 Policy Measures to Support Bank Lending.” BIS Quarterly Review September 2021.
- Kongsamut, Piyabha, Dermot Monaghan, and Luc Riedweg, 2021. “Unwinding COVID-19 Policy Interventions for Banking Systems.” Monetary and Capital Markets Department Special Series on COVID-19.
- Svoronos, Jean-Philippe and Rastko Vrbaski, 2020. “Banks’ Dividends in Covid-19 Times.” FSI Briefs 6, Financial Stability Institute, Bank for International Settlements, Basel.
- BCBS. 2021. “Early Lessons from the Covid-19 Pandemic on the Basel Reforms.” Basel Committee on Banking Supervision, Bank for International Settlements, Basel.

### Market liquidity, funding strains, and investment funds
- Barajas, Adolfo, Andrea Deghi, Samuel Fendoglu, and Yizhi Xu. 2020. “Strains in Offshore US Dollar Funding during the COVID-19 Crisis: Some Observations.” Global Financial Stability Notes 2020/01.
- Falato, Antonio, Itay Goldstein, and Ali Hortaçsu. 2021. “Financial Fragility in the COVID-19 Crisis: The Case of Investment Funds in Corporate Bond Markets.” Journal of Monetary Economics 123: 35–52.
- Hespeler, Frank and Felix Suntheim. 2020. “The Behavior of Fixed-income Funds during COVID-19 Market Turmoil.” Global Financial Stability Notes 2020/02.
- Eren, Egemen, Andreas Schrimpf, and Vladyslav Sushko. 2020a. “US Dollar Funding Markets during the Covid-19 Crisis—The Money Market Fund Turmoil.” BIS Bulletin 14.
- Eren, Egemen, Andreas Schrimpf, and Vladyslav Sushko. 2020b. “US Dollar Funding Markets during the Covid-19 Crisis—The International Dimension.” BIS Bulletin 15.
- Schrimpf, Andreas, Hyun Shin, and Vladyslav Sushko. 2020. “Leverage and Margin Spirals in Fixed Income Markets during the Covid 19 Crisis.” BIS Bulletin 2.
- Cavallino, Paolo, and Fiorella De Fiore. 2020. “Central Banks' Response to Covid-19 in Advanced Economies.” BIS Bulletins 21.
- Fleming, Michael and Francisco Ruela. 2020. “Treasury Market Liquidity during the COVID-19 Crisis.” Federal Reserve Bank of New York Liberty Street Economics, April 17, 2020.
- He, Zhiguo, Stefan Nagel, and Zhaogang Song. 2022. “Treasury Inconvenience Yields during the COVID-19 Crisis.” Journal of Financial Economics 143 (1): 57-79.

### Monetary policy, asset purchases, and financial conditions
- Adrian, Tobias and Nellie Liang. 2018. “Monetary Policy, Financial Conditions, and Financial Stability.” International Journal of Central Banking 14(1): 73–131.
- Adrian, Tobias, Dong He, Nellie Liang, and Fabio Natalucci. 2019. “A Monitoring Framework for Global Financial Stability.” IMF Staff Discussion Note 2019/006.
- Adrian, Tobias, Chris Erceg, Simon Gray, and Ratna Sahay. 2021. “Asset Purchases and Direct Financing: Guiding Principles for Emerging Markets and Developing Economies during COVID-19 and Beyond.” Departmental Paper No 2021/023.
- Rebucci, Alessandro, Jonathan Hartley, and Daniel Jiménez. 2020. “An Event Study of COVID-19 Central Bank Quantitative Easing in Advanced and Emerging Economies.” NBER Working Paper 27339.
- Powell, Jerome. 2020. “New Economic Challenges and the Fed’s Monetary Policy Review.” Jackson Hole Economic Policy Symposium.
- Powell, Jerome. 2021. “Opening Remarks: Monetary Policy in the Time of COVID.” Jackson Hole Economic Policy Symposium, August 27.
- Schnabel, Isabel. 2022. “Monetary Policy and the Great Volatility.” Remarks at the Jackson Hole Economic Policy Symposium.
- Bordo, Michael and Mickey Levy. 2022. “The Fed’s Monetary Policy Exit Once Again Behind the Curve.” Hoover Institution Economics Working Paper 22110.
- Wessel, David, and Eric. Milstein. 2022. “Taking Stock of the New Fed and ECB Monetary Policy Frameworks.” Hutchins Center on Fiscal & Monetary Policy at Brookings.

### Inflation, labor markets, fiscal limits, and supply bottlenecks
- Amiti, Mary, Sebastian Heise, Fatih Karahan, and Aysegül Şahin. 2022. “Inflation Strikes Back: The Return of Wage to Price Pass-Through,” Paper presented at the Advances in Monetary Economics Conference 2022.
- Bianchi, Francesco and Leonardo Melosi. 2022. “Inflation as a Fiscal Limit.” FRB of Chicago Working Paper 37.
- Crump, Richard, Stefano Eusepi, Marc Giannoni, and Ayşegül Şahin. 2022. “The Unemployment-Inflation Trade-off Revisited: The Phillips Curve in COVID Times.” NBER Working Paper 29785.
- Domash, Alex and Lawrence Summers. 2022. “How Tight are U.S. Labor Markets?” NBER Working Paper 29739.
- Celasun, Oya, Niels-Jakob Hansen, Aiko Mineshima, Mariano Spector, and Jing Zhou, 2022. “Supply Bottlenecks: Where, Why, How Much, and What Next.” IMF Working Paper 2022/31.
- de Soyres, Francois, Ana Maria Santacreu, and Henry Young. 2022. “Fiscal Policy and Excess Inflation during Covid-19: A Cross-Country View.” FEDS Notes, July 15, 2022.

### Corporate debt, solvency, and macro-financial vulnerabilities
- Blickle, Kristian, and João Santos. 2020. “The Costs of Corporate Debt Overhang Following the COVID-19 Outbreak.” Federal Reserve Bank of New York Liberty Street Economics, December 1.
- Jordà, Òscar, Martin Kornejew, Moritz Schularick, and Alan Taylor. 2022. “Zombies at Large? Corporate Debt Overhang and the Macroeconomy.” The Review of Financial Studies, 10: 4561-4586.
- Deghi, Andrea, Dulani Seneviratne, Tomohiro Tsuruga and Jerome Vandenbussche. 2021. “Corporate Funding and the COVID-19 Crisis.” IMF Working Paper 2021/086.
- Hanson, Samuel, Jeremy Stein, Adi Sunderman, and Eric Zwick. 2020. “Business Credit Programs in the Pandemic Era. Brookings Papers on Economic Activity, 3: 3-60.

### Cross-border spillovers, capital flows, and policy coordination
- Agénor, Pierre-Richard, and Luis A. Pereira da Silva. 2022. “Financial Spillovers, Spillbacks, and the Scope for International Macroprudential Policy Coordination.” International Economics and Economic Policy 19(1): 79-127.
- Avdjiev, Stefan, Cathérine Koch, Patrick McGuire, and Goetz Von Peter. 2018. “Transmission of Monetary Policy through Global Banks: Whose Policy Matters?” Journal of International Money and Finance 89: 67-82.
- Ghosh, Atish, Mahvash Qureshi, J. Kim, and J. Zalduendo. 2014. “Surges.” Journal of International Economics 92(2): 266-285.
- Ghosh, Atish, Jonathan Ostry, and Mahvash Qureshi. 2016. When Do Capital Inflow Surges End in Tears? American Economic Review 106(5): 581-585.
- Ghosh, Atish, Jonathan Ostry, and Mahvash Qureshi. 2017. “Taming the Tide of Capital Flows: A Policy Guide,” MIT Press.
- Scott, Davis and Andrei Zlate. 2022. “The Global Financial Cycle and Capital Flows during the COVID-19 Pandemic.” Globalization Institute Working Paper 416, Federal Reserve Bank of Dallas.
- International Monetary Fund. 2022c. “Review of the Institutional View on the Liberalization and Management of Capital Flows.” IMF Policy Paper No. 2022/008.

### Overarching Global Financial Stability and COVID-19 assessments
- International Monetary Fund. 2015. “Global Financial Stability Report April 2015: Navigating Monetary Policy Challenges and Managing Risks.”
- International Monetary Fund. 2019. “Global Financial Stability Report October 2019: Lower for Longer.”
- International Monetary Fund. 2020a. “Global Financial Stability Report April 2020: Markets in the Time of COVID-19.”
- International Monetary Fund. 2020b. “Global Financial Stability Update June 2020: Financial Conditions Have Eased, but Insolvencies Loom Large.”
- International Monetary Fund. 2021a. “Global Financial Stability Report April 2021: Preempting a Legacy of Vulnerabilities.”
- International Monetary Fund. 2021b. “Global Financial Stability Report October 2021: COVID-19, Crypto and Climate: Navigating Challenging Transitions.”
- International Monetary Fund. 2022a. “Global Financial Stability Report April 2022: Shockwaves from the War in Ukraine Test the Financial System's Resilience.”
- International Monetary Fund. 2022b. “Global Financial Stability Report October 2022: Navigating the High-Inflation Environment.”
- Avalos, Fernando, and Dora Xia. 2021. “Stress in European Money Market Funds at the Outbreak of the Pandemic.” BIS Quarterly Review September 2021.
- Barajas, Adolfo, Woon Gyu Choi, Pierre Guerin, Samuel Mann., and Yizhi Xu. 2021. “Loose Financial Conditions, Rising Leverage, and Risks to Macro-Financial Stability.” IMF Working Paper 2021/222.

*References list for "Macro-Financial Stability in the COVID-19 Crisis: Some Reflections", Working Paper No. WP/2022/251*

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_Source: https://www.imf.org/-/media/files/publications/wp/2022/english/wpiea2022251-print-pdf.pdf_