By Perry Mehrling

In a speech last week on “Policy Coordination Among Central Banks”, Ben Bernanke, US Federal Reserve chairman, drew attention to the way that the Fed’s swap line with other central banks has been used to facilitate lender of last resort funding for dollar-denominated assets held outside the US. Continue reading "Understanding the Fed’s swap line"

By Richard Portes

Expectations for the G20 meeting on November 15 are excessive. It will not agree on changes to the institutions of global governance, nor will it come up with an ‘n-point plan’ for dealing with the crisis. Continue reading "Capitalising on the crisis"

By Desmond Lachman

Among the more probable long-run casualties of today’s global and financial market crisis will be any further expansion of European monetary union. It is also more than likely that today’s global financial market crisis will mark the end of any serious challenge by the euro to the US dollar as an alternate international reserve currency.

A deep and long global economic recession will put severe strain on the current 15-country euro area. It will also expose the acute external vulnerabilities of those east European countries which aspire to full euro area membership. Continue reading "The threats to the eurozone’s expansion"

by Tito Boeri

The leaders of the eurozone finally agreed on a plan. It is a very ambitious rescue plan, as it should be, to stop the self-fulfilling prophecies that brought us to the brink of another Great Depression. But the plan should now be made acceptable also to European citizens.

In the next couple of weeks we shall see how effective these extreme measures are in reducing the spread between Euribor and the ECB refinancing rate. If they are successful, there will be no need to implement these measures. If they are not, public debts in the eurozone are bound to skyrocket. If they only partly succeed in reassuring markets, there will be sizeable outlays to the banking sector. The insurance on the interbank market is potentially very costly – before the crisis the overnight volumes in many Euro countries were of the order of 1-2 per cent of gross domestic product – while the bank recapitalization plans commit so far up to 20 per cent of the eurozone GDP and this share is bound to increase further as national plans are unveiled and countries are forced to raise capital to match the core tier one levels of UK banks (too bad that there was no cross-country co-ordination in this respect!).

Is public opinion in the EU ready to accept such potentially massive transfers of resources from the taxpayer to the banking sector? True, it is mainly gross debt that will  increase. By selling assets later on, net public debts may actually go down when the crisis is over. It is also true that in saving the banking system we ultimately save our economies and million of jobs. Nonetheless, there is a non-negligible risk that plans committing large resources to bank rescues will find strong opposition in national parliaments. Continue reading "How to make ‘bank socialism’ politically acceptable"

By Viral V. Acharya

The G7 and Eurozone meetings have raised hopes of expedient recapitalization of several banking sectors with the use of public funds. Such recapitalization is rightly aimed at shoring up equity base of the highly leveraged banks whose capital is essentially eroded, and of better-capitalized banks whose equity base has suffered too due to a spillover from adverse news about the highly leveraged ones. In light of this much-needed response to the global financial crisis, it is important to remember that following the first round of recapitalizations, regulators should and will look for ways to “clean up” the system. To this end, well-capitalized banks and financial institutions need to be given incentives to acquire weak banks sooner rather than later. Continue reading "Getting healthy banks to buy troubled ones"

by Peter Boone and Simon Johnson

The US government has moved dramatically, in what it argues is a comprehensive manner, to counteract serious problems in the financial system, and to reduce the risk of a serious recession or worse.  Eurozone policymakers are far more reluctant to intervene.  They remain inclined to handle growing bank failures on a case-by-case basis; and, while their central banks have provided liquidity, they have avoided using other fiscal and monetary policy tools.  If the fortunes of the world economy depended only on the US policy response, we would predict just a fairly severe recession.  The absence of any indication that there will soon be a decisive European policy response suggests we could be in for something considerably worse.

In the view that is increasingly prevalent in the US, we are not facing a Keynesian demand recession, nor the supply side shocks of the 1970s. It is a crisis of confidence very similar to the Asian crisis of 1997-98.  The lesson from these events is when trust in highly leveraged financial markets weakens, there can be long and enduring repercussions across all sectors of the economy. The Federal Reserve’s implicit policy model since September 2007 appears to be tied in part to those events.

In contrast, the frame of reference for European authorities appears to be drawn from the lessons of the 1970s.  They are concerned about inflation and second round effects from past commodity price rises, so they keep interest rates higher.  They have not announced national programmes to bail out financial institutions and borrowers, in part, because of perceived costs relating to future moral hazard. Continue reading "Why doesn’t continental Europe get it?"

Silliness is abroad in the UK. Some are arguing in favour of a looser monetary regime. I responded to this two weeks ago (“Britain must not cut loose its anchor”, May 15). Others are even muttering in favour of joining the eurozone, now celebrating its 10th birthday. Even my colleagues on the Lex column argued last week that the UK was close to meeting the economic tests for joining. The only obstacle to entry Lex could find was political.

Lex is wrong. Whether the UK meets arbitrary tests at a particular moment is irrelevant. What is right today may be wrong tomorrow. If a country is to join the eurozone, its people must be willing to cope with the consequences forever, however unpleasant they may sometimes be.

True, at present exchange rates, entry looks more plausible than for the past 12 years. The implied rate of the old D-Mark against the pound was 2.46 on May 23, well below the rate at which sterling was put in the old exchange rate mechanism in 1990. The real effective exchange rate measured by JPMorgan is 7 per cent below its average since the beginning of the 1980s. At present rates, adoption of the euro looks reasonable.

The remainder of this column can be read here. Comment from our expert panel appears below.

Read the debate - contributors so far include Willem Buiter and Andrew Smithers.

By Martin Wolf

“A full decade after Europe’s leaders took the decision to launch the euro, we have good reason to be proud of our single currency. The Economic and Monetary Union and the euro are a major success.” Self-congratulation is in order at birthday parties. So nobody should be surprised at the effusive remarks in the foreword by Joaquín Almunia, commissioner for economic and monetary affairs, to an excellent study of “Emu@10” (sic).*

How could anybody dare to question the achievements of the single currency? It is considered a credible rival to the US dollar. Jeffrey Frankel of Harvard even predicted in March that the “euro could replace the dollar within 10 years”.** This is a far cry from the scepticism, particularly in English-speaking circles, that greeted both its launch and the subsequent period of declining value against the US dollar. This is a credible currency.

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

Read the debate - contributors so far include Desmond Lachman, Roland Vaubel and Alberto Alesina