Central banks

By Eswar Prasad and Karim Foda

The global economic recovery is on the ropes, battered by political conflicts within and across countries, lack of decisive policy actions, and governments’ inability to tackle deep-seated problems such as unsustainable public finances that are stifling growth. Growth in global trade has weakened and the spectre of currency wars, with countries looking to maintain export competitiveness by keeping their currencies weak, has returned to the fore.

The Brookings-FT Tiger index shows growth momentum has dissipated in nearly all major advanced and emerging market economies. Central banks of the major advanced economies have responded with a range of conventional and unconventional policy monetary policy actions. These measures have put a floor on short-term financial market risks but have been unable to reverse declining growth momentum. As a result, financial markets continue to go through short-term cycles of angst and euphoria even as indicators of real economic activity remain mired in weakness. Read more

By Kevin P. Gallagher

Ben Bernanke, chairman of the US Federal Reserve, should be applauded for boldly putting employment over price stability in his latest move to keep interest rates low and to purchase mortgage-backed securities. Bernanke’s critics (and Bernanke himself) have rightly said that monetary policy is not enough, however. To truly generate employment-led growth in the US, those critics say more fiscal policy is needed.

There is also a need for stronger financial regulation in order to ensure that financial institutions do not steer newfound liquidity into currency and commodity speculation in emerging markets and developing countries—speculation that can wreak havoc on developing countries’ financial systems and growth prospects. Such was the case during previous rounds of interest rate declines and quantitative easing in the US, and could occur again. Read more

By Eric Lonergan

Despite running a large budget deficit in each of the past three years, the net debt of the UK government has barely risen.

The distinction between gross and net debt is central to any consideration of a government’s solvency. Gross debt usually refers to the total stock of current non-contingent financial liabilities of government, principally bonds outstanding, and net debt subtracts liquid financial assets held by government departments, such as foreign exchange reserves or holdings of government bonds.

Net debt is the basis for any calculation of fiscal solvency, as long as the assets held by government are highly liquid. If departments within the government hold gilts, it makes sense to net them off the stock of debt, because the government is making interest and principal payments to itself. Read more

Roger E A Farmer, Distinguished Professor and Chair, UCLA Department of Economics

The US recovery has stalled, the UK has fallen back into recession and most of Europe is mired in a debt quagmire to which there appears to be no quick exit. It is against this background that Charles Evans, president of the Federal Reserve Bank of Chicago, has come out aggressively in favor of additional Fed actions. Read more

By Domenico Lombardi and Sarah Puritz Milsom

Following the unprecedented downgrade of the European Financial Stability Facility and nine eurozone sovereigns by Standard & Poor’s, there is a renewed impetus for the International Monetary Fund to step up its involvement in the deepening euro area crisis. In an executive board meeting earlier this week, managing director Christine Lagarde requested that the membership step up the fund’s own war chest in an effort to better equip the institution to adequately confront the growing global threat. The move follows an earlier reshuffle at the helm of the European department of the IMF, signalling that the fund has been quietly preparing itself for the gloomiest scenario in which the situation in Europe develops into a full-blown systemic crisis.

Credit: Hannelore Foerster/Bloomberg

Currently, the IMF is unable to ring-fence the euro area and contain any spillovers to the global financial system unless its global membership agrees to provide a significant boost to its resources. As it stands, the organisation has some $385bn in its forward commitment capacity, including the activation of the contingent facility — the new arrangements to borrow — that can be used “to cope with an impairment of the international monetary system or to deal with an exceptional situation that poses a threat to the stability of that system.” Read more

By Thomas I. Palley

In his novel, The Jungle, the American muckraking author Upton Sinclair wrote about the horrendous work and sanitary conditions in the Chicago meat packing industry of the early 20th century. It is sometimes said Sinclair aimed for the heart but hit the stomach. That is because he aimed for progressive social and economic change, but instead his work prompted the founding of the Food and Drug Administration.

The same problem of missing the target confounds current discussions of the eurozone’s problems. What the euro lacks is a government banker, not a lender of last resort as is widely claimed. Read more

By Michael Pomerleano

In response to the financial crisis, the most immediate fundamental reform adopted by several developed countries is to have a “systemic regulator” overseeing the stability of the financial system as a whole. Through data gathering, analysis and ultimately regulation, the systemic regulator is expected is expected to mitigate the risks associated with highly inter-dependent relationships between financial institutions. Many central banks are receiving significant new responsibilities for macroprudential supervision. Changes to the UK regulatory framework in 2010 gave the Bank of England responsibility for microprudential and macroprudential regulation. In the US, the Dodd-Frank Act established the Financial Stability Oversight Council, to be led by Treasury Secretary including the heads of the Federal Reserve, the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency.

Several arguments have been put forward for justifying why central banks are receiving a prominent role in macroprudential supervision: financial supervision offer insights into the condition of financial institutions that is essential in the conduct of monetary policy; and central banks are inextricably involved in the financial stability function through their lender-of-last-resort function. Read more

Ben Bernanke, US Federal Reserve chairman, has announced that the Fed is about to go on a $600bn spending spree by buying $75bn of treasury bonds every month for eight months. Not all of the members of the Federal Reserve Open Market Committee agree that a second round of quantitative easing is a good idea. Read more

If he were still alive today, what would Milton Friedman think of his disciple, Ben Bernanke? This is a matter of some concern to the Fed chairman, who is reported as saying to colleagues on Saturday: “I grasp the mantle of Milton Friedman…I think we are doing everything (he) would have us do.” With libertarian economists tending to be among those most critical of QE2, Mr Bernanke is relying on Friedman’s halo effect to enhance the legitimacy of the Fed’s recent actions. Friedman’s friends say that his opinions were unpredictable, which is what made them interesting. But some some free market economists, like Allan Meltzer, claim that Friedman would have strongly disapproved of QE2. Are they right? Read more

From Gavyn Davies’ blog:

Ben Bernanke’s speech in Boston on Friday seems to have disappointed those who were expecting him to announce concrete measures to restart quantitative easing, but we already knew from the last set of FOMC minutes that the groundwork for such an announcement had not been undertaken. That announcement will come after the committee’s next meeting on November 2nd and 3rd. Nevertheless, Mr Bernanke has nailed his colours to the mast, even more clearly than he has done in recent speeches. This is a Fed Chairman who is very dissatisfied with the depressed state of the US economy, and who is not afraid to say so. Read more

The US Fed’s policy-setting committee (FOMC) undertook large asset purchases last year, buying $1.7 trillion of mortgage-related and Treasury bonds. Last month, the Fed reaffirmed the easing bias and indicated that it could start buying vast quantities of government debt if unemployment did not improve. Read more

There is a widespread perception that quantitative easing is synonymous with increasing the money supply. But it is more than that. Read more

Update: Read Prof Farmer’s response to readers’ comments

By Roger E. A Farmer

I argue in this piece that:

  • Quantitative easing should be expanded
  • Even if the Bank of England were to buy the entire UK national debt that this policy would not be inflationary
  • The global recovery is faltering and an expansionary policy is needed to encourage private investors to create jobs
  • Additional quantitative easing could save as much as £38.5bn a year in interest costs to the taxpayer

May 18, 2006 was an important day. It was the day when the Bank of England began to pay interest on reserves. In October 2008 the Fed followed suit. This monumental change in policy gave the Bank an important new tool in its arsenal. It allowed the Bank to influence the economy not just through expansion or contraction of the stock of money, but also through the composition of its balance sheet. Read more

By Thomas I. Palley

The great German physicist Max Planck remarked that “science advances one funeral at a time.” The situation is worse in economics, which is subject to regress, as happened when the valuable but imperfect insights of Keynesianism were supplanted by the ideological blinkers of neo-liberalism.

The effects of this regress have again been on display in the confused discussions and policy responses to Europe’s sovereign debt crisis. The fact is that countries which borrow in their own currency and control their money supply will never default because they can always issue the money needed to repay their debts.

For such countries, central banks should respond to speculative debt crises with “bear squeeze” tactics that have them buy existing debt. In this fashion, countries can buy back debt below par value, in effect repaying it on the cheap. It is what the European Central Bank should have been doing on behalf of its member countries. Read more

By Kevin P. Gallagher

At the recent annual meeting of the Asian Development Bank Taiwan’s Central Bank governor Perng Fai-nan urged emerging market nations in Asia to use capital controls to promote financial stability.

Yesterday, this call was echoed by Noeleen Heyzer, executive secretary of the United Nations Economic and Social Commission for Asia and the Pacific. She singled out China, India, Singapore, Indonesia and South Korea as the most vulnerable nations in need of controls

These statements would have been unthinkable a decade ago, and shows how much has changed.

Part of the stigma attached to capital controls has been dampened by the new tune at the International Monetary Fund (IMF). In a February 2010 staff position note and in the IMF‘s Global Financial Stability Report (GSFR) the IMF said that capital controls are a legitimate part of the toolkit for emerging markets. What’s more, the IMF’s economists found that those countries that deployed capital controls in the run-up to the current crisis were among the least hard hit from the global financial crisis.

It is time for the debate over capital controls to shift from whether to deploy controls to how and when.

The problem is that many of the world’s trade and investment treaties, especially those with the US, make it very difficult to effectively use capital controls. Read more

Shankar Acharya

In March the Reserve Bank of India (RBI) published the balance of payments data for the October-December quarter of 2009. It elicited surprisingly little comment. Surprising, because for the second quarter in a row the current account deficit was well above 3 per cent of GDP. Read more

By Michael Pomerleano

Developing and developed countries alike are inextricably connected in the international financial system. Yet this system is heading into strong headwinds and a dangerous period in which vulnerabilities will increase in the international financial system. Read more

By Roger E. A Farmer

Anyone who thinks that the 2008 financial crisis is a new and unusual event on the world stage should read Walter Bagehot’s book, Lombard Street, written in 1873. Bagehot was editor-in-chief of The Economist magazine and the son-in-law of its founder James Wilson. He literally wrote the book on central banking.  Read more

By James Park

In October 2008, the flow of money stopped. As Lehman Brothers teetered on bankruptcy, the US financial system went into septic shock – from toxic assets representing worthless derivatives and collateralised debt obligations. To capture the gravity of the situation, the media latched onto metaphors.  Warren Buffett called that October the economic equivalent of a Pearl Harbor.

While Buffet’s martial analogy serves to highlight the fall in the inter-institutional lending, a more apropos analogy is that the financial system found itself in the intensive care unit with the diagnosis of septic shock.

 Read more

So what did I make of this year’s annual meeting of the World Economic Forum at Davos? It felt like sitting at the bedside of somebody who had survived a heart attack but was unsure how long it would take to recover full vigour, if, indeed, he would at all. The mood of “Davos men” (yes, they mostly still are) was, as my colleague, Gideon Rachman, has pointed out, one of anxiety. Meanwhile, the participants in a still predominantly western meeting looked at the youthful vigour of emerging economies with admiration, envy and even fear.

For me, the highlight of the programme was the economic outlook session on Saturday.* This is not only because I was moderator. The starting point for the discussion was an obvious one: the policy interventions of late 2008 and 2009 have been a resounding success. The outcome has been a far briefer and shallower recession than most participants imagined a year ago. That is obvious from the successive consensus of forecasts for 2010. For almost every significant economy, the forecast for growth this year is higher than it was a year or even six months ago (see charts). The world economy survived the heart attack in the financial system. Read more