By Martin Wolf

Whatever else it may be, the Federal Reserve is not boring. Indeed, by the standards of other central banks, it is hyperactive. The shock 0.75 percentage point reduction in the Federal Funds rate of interest last week, particularly if followed by the widely expected 0.5 percentage points on Wednesday, is a dramatic example. The Fed is the exemplar of an activist central bank. But US fiscal authorities are not far behind, as the $150bn (just over 1 per cent of gross domestic product) fiscal package going through Congress demonstrates.

So what are the US monetary and fiscal authorities trying to do? Will it work? What are the risks? Should others follow suit? The urgency of these questions was made clear at the annual meetings of the World Economic Forum in Davos last week. The consensus was gloomy. Comfortingly, the Davos consensus is usually wrong. The Fed is certainly trying to prove it so this time.

The answer to the first question is: apply “risk management”. That approach is associated with Alan Greenspan, the former Fed chairman. But it is also central to the thinking of the Fed under Ben Bernanke.

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

By Lawrence Summers

Markets and perceptions of the economic outlook change rapidly. Even two months ago most observers doubted predictions of a US recession, saw no need for a fiscal stimulus, and thought that inflation fears should constrain monetary policy. Now, Washington is more or less settled on a stimulus package that will exceed $150bn; markets at one point last week expected a Fed funds rate below 2 per cent by September. The debate about recession is now about how deep and global its impact will be.

There is enormous uncertainty around economic or financial forecasts. It is possible that pessimism will recede as declining interest rates and dollar exchange rates increase demand. It is more likely, though, that the situation will deteriorate further as perceptions of declining growth increase credit spreads and risk premiums in financial markets, leading to reduced lending, borrowing and spending exacerbating the pessimism about growth.

Perhaps inevitably given the complexity of the problems, policy measures have seemed ad hoc and reactive: measures to increase bank liquidity one week; to help homeowners avoid foreclosure another; to work towards fiscal stimulus another; to lower interest rates most recently. Confidence would be well served by a comprehensive programme of measures that offers the prospect of accelerating growth and insures against a prolonged downturn. Until that happens, it will be difficult for confidence to return.

Substantial monetary and fiscal stimulus is now in train. This will reduce the severity of any recession and provide some insurance against a protracted downturn. Along with macro-economic stimulus in the US, there is the need for further policy development in three other areas – repair of the financial system, containing the damage caused by the housing sector and assuring the global co-ordination of policy.

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

By Stephen Cecchetti

Tuesday morning’s sudden interest rate cut by the Federal Reserve’s Open Market Committee came as a shock even to those of us who live and breathe this sort of thing. The 75 basis point reduction to 3.5 per cent in the committee’s target for the overnight interbank lending rate was the largest single day move since the Fed adopted its current procedures in 1982. Not only was the action unprecedented in size, it was taken following a quickly organised conference call during the evening of a national holiday.

The immediacy of the cut has its genesis in both the deterioration of macroeconomic conditions over the week ending last Friday, combined with the equity market collapse, and the possible desire of chairman Ben Bernanke and his colleagues to change the committee’s modus operandi.

Up until this week, all of the Fed’s actions – both the more and less conventional – have been directed at keeping debt markets working. Starting with Mr Bernanke’s speech on January 10, 2008 it is clear that policymakers felt they had failed to keep the financial crisis from influencing the real economy. With global stock markets in freefall the need for immediate action became apparent. The Fed was planning to cut rates in 10 days anyway so why not bring the action forward to soothe markets and avoid a meltdown? While the inter-meeting action does not signal an emergency, it does confirm the plan for a dramatic easing.

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

By Lawrence Summers

The odds of a 2008 US recession have surely increased after a very poor employment report, growing evidence of weak holiday spending, further increases in oil prices, more dismal housing data and further writedowns in the financial sector. Six weeks ago my judgment in this newspaper that recession was likely seemed extreme; it is now conventional opinion and many fear that there will be a serious recession. Markets now predict the Federal Reserve will provide further stimulus to the economy by cutting rates by an additional 125 basis points on top of the 100 basis points they have already been cut so that rates fall to the 3 per cent range.

There is now a compelling case for the president and Congress to create a programme of fiscal stimulus to the US economy that could be signed into law in the next several months.

Given the market’s prediction of Fed policy actions, the debate now is not about whether or not to provide macro­economic stimulus. That question appears to be settled. The question is whether it is better for all the stimulus to come from discretionary monetary policy or for some of the stimulus to come from discretionary fiscal policy. A diversified policy approach seems clearly preferable in that (i) in a world where judging the impact of policy measures is difficult, the outcome is less uncertain with a diversified mix of stimulus measures; (ii) the proximate impact of fiscal policies is felt by the families bearing the brunt of recession, in contrast to monetary policies whose immediate impact is on financial institutions; (iii) use of fiscal policy reduces the amount by which interest rates have to be reduced, thereby reducing downward pressure on the dollar, which in turn contributes to upward pressure on US inflation and international instability; (iv) partial reliance on fiscal policy mitigates the various risks of bubble creation associated with excessively low interest rates.

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

By Martin Wolf

Is the US going to experience a recession? Two answers must be given to this question: nobody can be sure; and it does not matter. A much more important question is whether the US economy continues to experience a “growth recession”, by which is meant a lengthy period of sub-trend growth. The answer is that it will.

The standard US definition of a recession is two quarters of negative economic growth. This demands both too much and too little: too much because it requires an absolute fall in output, which is an infrequent event in a growing economy; too little, because it is consistent with rising unemployment and declining capacity utilisation. But a lengthy growth recession is likely to be far more disturbing even than a sharp recession, provided the latter ends swiftly.

Most analysts believe that the trend rate of growth of the US economy is around 3 per cent a year. Growth at below that rate, then, is a growth recession. This year, the expectation is for growth of about 2 per cent. Next year, suggests the consensus, it will be a little above 2 per cent. That would mark a cumulative shortfall of about 2 per cent of gross domestic product over two years. So the US is already in a growth recession.

The remainder of this column can be read here. Debate from our guest columnists appears below.

By Lawrence Summers

The falling dollar generates anxiety almost everywhere. Americans and those dependent on American growth worry about the proverbial "hard landing" as inflation and interest rates rise with a weakening dollar, causing asset prices and output to fall. Europeans and others with currencies that float freely against the dollar worry that their currencies will bear a disproportionate share of the dollar’s decline and appreciate too far, leading to competitiveness problems. The falling dollar risks rising inflation, asset bubbles and the loss of macroeconomic control in countries that have tied their currencies to the dollar’s sagging mast.

The dollar’s decline may provoke anxiety but it should not be a surprise to anyone who has followed the global economy in recent years. History suggests that periods when a country’s economy turns down, short-term interest rates are declining and financial strains are increasing are likely to be periods when a nation’s currency depreciates. Moreover the US current account has for years now been financing consumption rather than investment, with the financing coming increasingly from debt rather than equity and shorter rather than longer-term debt.

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

The writer is the Charles W. Eliot professor at Harvard University.

By Martin Wolf

"I regret to say that the Federal Reserve independence is not set in stone. FOMC discretion is granted by statute and can be withdrawn by statute." Alan Greenspan, The Age of Turbulence.

To critics it is now the "Bernanke put" - the belief that, as under Alan Greenspan, the US Federal Reserve will always ride to the rescue of Wall Street. The jubilant response of traders to the Fed’s 50 basis point cut in the short-term interest rate might justify this suspicion. But saving Wall Street from its follies is not the Fed’s objective. It is an (unfortunate) by-product of the attempt to do its job.

It would be wonderful if those responsible for this most absurd of financial crises could be punished without damaging millions of innocent bystanders. But it is impossible. If the Fed does its job, it helps the financial sector. The latter will, no doubt, recover and then find some new, imaginative and currently unforeseen way to generate a possibly bigger crisis several years hence. Whereupon, it will expect the Fed to do its job, as Wall Street sees it: saving the economy, by saving finance. Moral hazard matters, but only for the poor.

Yet will the Fed always be able to oblige? The answer is not so clear. The resolution of each crisis lays the seeds of the next. Thus, the easing by the Fed after the east Asian and Russian crises of 1997 and 1998 contributed to the subsequent stock market bubble. The dramatic easing after its bursting in 2000 contributed to the recent housing boom. The disruption in money markets brought about by the end of that boom has led to last week’s sharp cut in rates. The question, then, is what this will lead to.

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“Over the past decade a combination of diverse forces has created a significant increase in the global supply of saving – a global saving glut – which helps to explain both the increase in the US current account deficit and the relatively low level of long-term real interest rates in the world today.” Ben Bernanke, chairman of the Federal Reserve.*

Has the Federal Reserve been a serial bubble-blower? Or has it been responding to exceptional macroeconomic conditions? Not surprisingly, the implication of Ben Bernanke’s celebrated speech on the global “savings glut” implies the second view. Yet his self-exculpatory perspective is far from universally shared. So who is right? My answer is both. The Fed can indeed be accused of being a serial bubble-blower. But this is not because it has been managed by incompetents. It is because it has been managed by competent people responding to exceptional circumstances.

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By Kenneth Rogoff

The Bush administration was beside itself with glee earlier this month when it announced that the fiscal year 2007 federal deficit was set to fall to just over $200bn, or 1.5 per cent of US gross domestic product. Although the continuing deficit hardly makes the US a picture of fiscal prudence, the dollar amount is less than half what it was in 2004.

Publicly, some Democrats are still condemning Bush II profligacy and preaching a return to Clinton I fiscal conservatism. Privately, though, many are starting to question why a 2008 Democratic president should bother improving the government’s balance sheet if the end result is just a bigger pot for a future Republican president to lavish on his or her friends. Certainly the 2000s, even as long-term interest rates normalise, seem to have thrown cold water on the notion that sustained US budget deficits will automatically lead to high interest rates and low growth. Or have they?

First, the good news. Explosive financial globalisation has made US federal budget policy far less important as a determinant of global real interest rates. Instead of interest rates going up sharply, low levels of public and private saving in the US have helped sustain a massive current account deficit. Continuing foreign inflows are probably holding down US real interest rates by at least 1.5 per cent and possibly more.

And let us give credit where credit is due. The Bush administration’s decision to borrow massively, over a period where global long-term interest rates fell massively, was not a bad market call.

The remainder of this column can be read here (FT.com subscription required). Discussion from our guest economists is free.

By Lawrence Summers

Three months ago I was able to write in this space that in economics “the main thing we have to fear is the lack of fear itself”. This is no longer true today. With clear evidence of a crisis in the subprime US housing sector, risks of its spread to other credit markets, sharp increases in market volatility, reminders of the fragility of global carry trades and signs of slowing economic growth, there is enough apprehension to go around. While it would be premature to predict a US recession, there are now strong grounds for predicting that the US economy will slow down very significantly in 2007. Whether in retrospect 2007 will prove to have been a “pause that refreshed” a nearly decade-long expansion like the growth slowdowns in 1986 and 1995 or whether it will see the end of the expansion is not yet clear. It is clear though that the global economy has been relying on the US as an importer of last resort; that the US economy has been relying on the consumer for its primary impetus; and that until now consumers have been encouraged to spend their incomes fully or more than fully by being able to access the wealth in their homes.

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