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.

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.

By Alan Greenspan

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.

By Kenneth Rogoff

As the global economic crisis hits its one year anniversary, it is time to re-examine not just the strategies for dealing with it, but also the diagnosis underlying those strategies. Is it not now clear that the main macroeconomic challenges facing the world today are an excess demand for commodities and an excess supply of financial services? If so, then it is time to stop pump-priming aggregate demand while blocking consolidation and restructuring of the financial system.

The huge spike in global commodity price inflation is prima facie evidence that the global economy is still growing too fast. There is nothing sinister in this. The world has just experienced perhaps the most remarkable growth boom in modern history. Given the huge cumulative rise in global growth during the 2000s it is little wonder that commodity suppliers have found it increasingly difficult to keep up, even with sharply rising prices.

For many commodities, particularly energy and metals, new supply requires long lead times of five to 10 years. In principle, the demand response is more nimble, but it has been greatly dulled by a wide variety of subsidies and distortions in fast-growing emerging markets.

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

By Lawrence Summers 

Anyone who cares about the health of the US economy should welcome the enactment of the Treasury’s rescue plan for Fannie Mae and Freddie Mac, along with other measures to support the housing market. While there is room for argument about details, the risks to the financial system were too great to allow delay.

No one should suppose, however, that the issue is now satisfactorily resolved, even for the short term. Emergency legislation was necessary because market participants were unwilling to buy Fannie and Freddie’s debt; investors doubted that the government-sponsored enterprises were healthy enough to repay it and did not draw sufficient reassurance from the implicit guarantee of federal support. If their debt proves easier to place now, it is only because this guarantee has been strengthened, not because anything has changed at the GSEs.

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

By Joseph Stiglitz

Much has been made in recent years of private/public partnerships. The US government is about to embark on another example of such a partnership, in which the private sector takes the profits and the public sector bears the risk. The proposed bail-out of Fannie Mae and Freddie Mac entails the socialisation of risk – with all the long-term adverse implications for moral hazard – from an administration supposedly committed to free-market principles.

Defenders of the bail-out argue that these institutions are too big to be allowed to fail. If that is the case, the government had a responsibility to regulate them so that they would not fail. No insurance company would provide fire insurance without demanding adequate sprinklers; none would leave it to “self-regulation”. But that is what we have done with the financial system.

Even if they are too big to fail, they are not too big to be reorganised. In effect, the administration is indeed proposing a form of financial reorganisation, but one that does not meet the basic tenets of what should constitute such a publicly sponsored scheme.

First, it should be fully transparent, with taxpayers knowing the risks they have assumed and how much has been given to the shareholders and bondholders being bailed out.

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

By Paul De Grauwe

The financial crisis continues to create victims. Not only people but also some of our most cherished ideas risk falling by the wayside. Take the hugely influential idea that financial markets are efficient. Its proponents told us that when financial markets were left free, they would work miracles. Savings would be channelled to the most promising investment projects, thereby boosting economic growth and welfare. In addition, these financial markets would spread risk around over a large number of participants, thereby lowering the risk of doing business, again boosting growth and welfare. In order to achieve these wonders, financial markets had to be freed from the shackles of government control.

The country that embodied these principles most was the US. Helped by the missionary zeal of successive American administrations and pushed by international financial institutions, country after country freed their financial markets from pernicious government controls, hoping to share in these economic wonders.

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

by Edmund Phelps

Many people see every downturn of employment from a long-sustained plateau as a fall of aggregate demand - “effective demand” in Keynes’s terms. They would have the central bank cut interest rates to restore that demand.

If employment is down because of aggregate demand, the problem can be addressed at zero cost through rate cuts and the ensuing rise in the money supply. Many central banks like to do that: to “lean against the wind”.

This time, though, there are forebodings of “stagflation” - lower employment without the solace of lower inflation. Some economists instinctively feel that the present downturn is the effect of structural shifts in the economy, not a shift in aggregate demand. They doubt that a central bank should retard effects it cannot prevent.

If employment is down because of shifting structures, gearing the money supply to attempt to prop up employment would generate ever-rising inflation. Inflation expectations would break loose from their moorings and the attempt would fail. Some central banks are refraining from rate cuts.

We have a difference of opinion and of policy. But the structuralist case needs to be argued. What are the primary forces of a structural nature? And, crucially, what are the nonmonetary channels through which these forces have structural impacts on the economy - on the size of the labour force and the natural rate of unemployment?

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

by Martin Wolf

It is now almost a year since the US subprime crisis went global. Many then hoped that the repricing of risk would be no more than a brief interruption in the progress of the US and world economies. Such hopes have been disappointed. The woes of Fannie Mae and Freddie Mac, the tumbling stock markets and the climbing oil prices make clear how far the turmoil is from its end. It has, in all likelihood, not even passed the end of its beginning.

So where is the world economy now? And where might it go? Here are some preliminary answers to these questions.

The answer to the first comes in two main parts: continued financial distress and commodity price rises.

The performance of banking stocks tells one most of what one needs to know about the financial crisis. In the US, the epicentre of the distress, banks had lost half of their market value between a year ago and the end of last week, relative to the S&P composite index.

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

by Ricardo Caballero

Here we go again. Two pillars of the US and world financial system, Fannie Mae and Freddie Mac, have become embroiled in the current financial turmoil. To be sure, nobody in their right mind expects these institutions to stop operating; the issue instead is whether, how and when a government intervention takes place.

Treasury secretary Henry Paulson has just announced a first package of all out support that involves contingent credit and possibly equity. The terms of the latter are yet unclear but they harbor hope that Treasury has realized how dangerous its previous anti-stockholders strategy had become. Only last Friday the rumor had it that Secretary Paulson was insisting that any potential government rescue plan would not benefit the companies’ shareholders. In fact, if he were to continue with the modus operandi he adopted during the recent Bear Stearns intervention, not only shareholders would not benefit, but they would be “exemplarily” punished.

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