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The crisis: a tale of two monetary policies

August 8th, 2008 2:37am
by FT

By Martin Feldstein

The European Central Bank and the Federal Reserve are facing similar problems but pursuing different policies. The ECB has been raising interest rates while the Fed has been cutting them. The overnight federal funds rate is now 2 per cent while the corresponding ECB rate is 4.25 per cent. Which central bank is doing the right thing? Or could they both be?

Inflation is a significant problem in both the eurozone and the US, with a headline consumer inflation rate over the past 12 months of 4 per cent in the eurozone and 5 per cent in the US. Both economies are also facing declining economic activity with falling employment and lower industrial ­production.

The sharp rise in the prices of energy and food during the past 12 months will undoubtedly spill over into higher prices for other products in both the US and Europe. The primary challenge for both central banks is to limit this inflationary shock to a one-time pass through, avoiding the rise in wages that would occur if employees attempted to offset the decline of their real incomes. It was that futile wage-price spiral that drove inflation rates in the 1970s to double-digit levels. Preventing a repetition of that requires convincing the public that today’s high inflation rate will soon decline.

The remainder of this column can be read here. Debate from our panel of economists appears below.

August 8th, 2008 2:37am in Credit squeeze | Permalink | Comment

Welcome to a world of diminished expectations

August 6th, 2008 9:26am
by FT

by Willem Buiter

From a cyclical perspective, things look bad for Europe, the US and most of the global economy. My contribution to summer cheer is to note that longer-term local and global economic prospects are likely to be worse than expected. So welcome to boom and bust. Welcome to subdued long-term growth prospects.

The ancient Greeks knew hubris to be one sin the gods will punish. When Gordon Brown, the British prime minister, announced “the end of boom and bust”, Jove must have checked his thunderbolts. Capitalist market econ­omies are inherently cyclical. The private credit system is intrinsically prone to alternating bouts of irrational euphoria and unwarranted depression. Busts play an essential role. They clean up the mess created during the boom by inflated expectations, overoptimistic plans and unrealistic ventures. These become embodied in unsustainable household debt, productive capacity with no foreseeable use, excessive corporate and financial sector leverage and enterprises whose only asset is hope. The correction is painful, even brutal: unemployment rises, as do defaults, repossessions and bank­ruptcies. We entered such a cathartic phase around the turn of the year in both the US and the UK. Continental Europe is not far behind.

The remainder of this column can be read here . Debate from our panel of economists appears below.

August 6th, 2008 9:26am in Central banks, Climate change, Emerging economies, World trade | Permalink | Comment

Repel the calls to contain competitive markets

August 5th, 2008 4:35am
by FT

By Alan Greenspan

Ferguson illustration

The surprise of recent months is not that global economic growth is slowing, but that there is any growth at all. The credit crunch of the past year has not followed the path of recent economically debilitating episodes characterised by a temporary freezing up of liquidity – 1982, 1989, 1997-8 come to mind. This crisis is different – a once or twice a century event deeply rooted in fears of insolvency of major financial institutions.

This crisis was not brought to closure by the world’s central banks’ injection of huge doses of short-term liquidity. Only when sovereign credits were substituted for private bank credit, first in the case of the UK (Northern Rock) and subsequently in the case of the US (Bear Stearns), was a semblance of stability restored to markets. But the London Interbank Offered Rate spreads on overnight index swaps and credit default swaps of financial institutions have not returned to the modest pre-crisis levels. Fears of insolvency have not, as yet, been fully set aside. There may be numbers of banks and other financial institutions that, at the edge of defaulting, will end up being bailed out by governments.

The remainder of this column can be read here. Debate from our panel of economists appears below.

August 5th, 2008 4:35am in Credit squeeze | Permalink | Comment

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