Full of Passionate Intensity

An Interview with Sir Mervyn King

The jargon that economists use for this is fiscal dominance. That is: the government decides it would like to spend a lot of money, and it then tells the central bank that it has to print enough to finance that. I don't think this is a problem today, but if we were to come out of this and if the independence of central banks in two or three years’ time in respect of setting interest rates and the amount of QE they engage in — if that is determined by pressure from government rather than by an independent central bank with a mandate for price stability, then I think we ought to be worried about a future inflation. If central banks can retain their independence, then I don't think there's any reason to suppose that we should find inflation a major problem.

OR: Do you worry about an emerging markets crisis with possible knock-on effects globally?

King: I think this is a real risk. Go back to the end of 2019, before the pandemic: I was certainly worried that we had not really solved the problem of the disequilibrium into which the world economy had tipped before, during, and indeed after the financial crisis, and that the amount of debt in the world as a whole was higher last year than it was in 2007. My concern was that there might be a small number of defaults, which in themselves were not very significant, but nevertheless were a signal to the market that there could be debt defaults. Then you would see sentiment deteriorating around the world, rather like what happened in September 2007, and that would immediately put pressure on the capital positions of many financial intermediaries and banks around the world and that could trigger another crisis.

Some countries in emerging market economies did not start this episode with comfortable levels of debt. Their levels of debt, especially in foreign currency, could have caused a problem in any event, and this will exacerbate it. That could be the trigger for the start of a wave of defaults, which would lead to a wider crisis. The banking system in the United States is a good deal more robust than it was before the financial crisis, and it's also a good deal more robust than the banking system in most other parts of the world. Certainly in Europe, I would worry that the banking system is not in good shape and would find it difficult to withstand the significant number of defaults.

Countries in the developing world, which have for very understandable reasons weak health systems, are going to be in an extremely difficult position. The impact on their economies will mean they're not in a good position to cope with significant expansions of national debt. I do think that many of these countries could suffer far more even than we in the West are suffering and they won't be in a strong position to withstand it, and we will see many more defaults on debt than we would have expected to see only a few months ago. In turn, that could be a trigger for a very wide financial crisis.

But the whole spirit of what I've been saying, and what John Kay and I write about in our book, is that we need to avoid bogus quantification. Don't predict things, be very honest about what you know and what you don't know, and be prepared. Think about resilience of systems.

OR: Do you see governments issuing very long-term debt as a potential solution here? Wouldn't that be a way of limiting risk going forward? Do you have a sense as to why that's not being done?

King: I think it does make sense to issue much longer-term debt. I think one of the slightly odd features of national debt across the world is that for historical reasons, countries like the United Kingdom have a much higher duration of our national debt than most other developed countries. I think that's a sensible position to be in because it minimizes the rollover risk of having to refinance debt at much higher interest rates than you can now — why not lock into these low interest rates? The other side of the coin, however, which may be affecting policymakers is the question of who's going to buy this debt. One of the concerns that I was certainly worried about before this episode was that pension schemes which were buying long-term debt at very low interest rates would be viable only if they could charge much higher contributions than their members have been used to. We had seen the demise of defined-benefit pension schemes, and even for defined-contribution schemes. The amount of money that people had to put into their pension pot in order to have adequate pensions was becoming extremely high. Pension schemes as such were not looking terribly attractive at very low interest rates. What we do not want to see are pension funds, pension schemes, and indeed insurance companies ending up in a position where they too move towards insolvency because they can't finance the liabilities they've incurred.

OR: What is the genesis of your (very timely) book?

King: John and I had written a book together 40 years ago on the British tax system, and our careers then went in rather different directions. John became a very successful business consultant. He was first head of the business school at Oxford and a well-known contributor to the Financial Times. I became an academic and I was for the first half of my career, and then I went to the Bank of England as chief economist and stayed on as deputy governor and then governor for 10 years. At the end of my time as governor, we had a conference at the Bank of England and John and I both made contributions to it. We discovered that quite independently, we had come to the view reflecting on the financial crisis and what people had said about the 1930’s.