Daily Archives: February 16, 2012

The release of the minutes from the January 24-25 Federal Reserve meeting on Wednesday was one of the most anticipated ever. The wait proved worthwhile as the minutes went beyond just providing additional information on historic Fed decisions. They also shed light on the future of its balance sheet operations and some of the challenges that its unusual policy activism faces in this fluid economic and political environment.

You should have no doubt. The Fed remains one of the most activist, imaginative and courageous central banks in the world. Motivated by the uncertain economic outlook and the reticence of other policymakers who are much better placed to remove impediments to growth and job creation, it feels compelled to do even more to boost the US economy. Yet the its ability to deliver good outcomes is tempered by the fact that it is experimenting, deploying untested tools with inadequate support from other policymakers.

The bad news is that we will not know for a while whether the Fed’s unusual activism will work. However, when the time finally comes – and here is the good news – historians will have an unusual amount of information to understand the content in which innovations and important decisions were made. 

When discussing Greece, some policy officials and market participants have suggested that ‘the markets are now better prepared to deal with a default’. When was the other time such statements were being made? Probably in mid-September 2008, a few days before the collapse of Lehman Brothers.

If there is one thing to learn from the past five years, it’s that financial contagion operates in unexpected ways, especially after a major shock such as the failure of a major financial institution or the default of a country. Even if markets have prepared for the possibility of a default by Greece, the practical consequences of such an event can be much greater.

Greece does not suffer from a typical balance of payment problem. It has a major structural problem that can be resolved only through a combination of macroeconomic, structural and social measures. What is required is much more similar to the kind of programme that the International Monetary Fund applies to low-income countries, under the Poverty Reduction and Growth Facility (recently renamed Extended Credit Facility), with official financing provided for several years, at concessional terms to ensure debt sustainability. Strong conditionality has to be implemented, in line with the IMF practice for this type of programme, but not under the threat of continuous default that alienates the political support in Greece for the right policies and fuels instability in financial markets.