Bernanke Says Fed Has Options as Rates Near Zero

REUTERS; December 1, 2008

AUSTIN, Texas (Reuters) – Federal Reserve Chairman Ben Bernanke on Monday urged decisive action to protect the economy and said the central bank had alternative tools it could employ to help as interest rates approach zero.

“Our nation’s economic policy must vigorously address the substantial risks to financial stability and economic growth,” Bernanke told the Greater Austin Chamber of Commerce.

On a day when the arbiter of U.S. business cycles said the United States fell into recession last December, Bernanke said the economy was still under “considerable stress” and had slipped further since markets crumbled anew in September.

“Households have continued to retrench, putting consumer spending on a pace to post another sharp decline in the fourth quarter,” the Fed chief warned.

Bernanke said further cuts in overnight interest rates beneath the Fed’s current target of 1 percent were “certainly feasible,” but he suggested the U.S. central bank would also use other unconventional measures to spur growth.

“Although conventional interest rate policy is constrained by the fact that nominal interest rates cannot fall below zero, the second arrow in the Federal Reserve’s quiver — the provision of liquidity — remains effective,” he said.

He said the Fed could directly purchase “substantial quantities” of longer-term securities issued by the U.S. Treasury or government-sponsored agencies to lower yields and stimulate demand.

Bernanke also said the Fed could side-step institutions that are reluctant to lend and pump money directly into specific markets. The Fed has already done this in the market for commercial paper, short-term debt companies use to finance day-to-day operations, and last week it announced a program to push funds into markets for consumer-related debt as well.

U.S. Treasury prices rose sharply, pushing yields to their lowest in five decades, as expectations built the Fed would become a large buyer. Prices for stocks, however, cratered. The Dow Jones industrial average closed down nearly 680 points, or 7.7 percent <.DJI>.

GOING TO ZERO?

The Fed is widely expected to lower benchmark U.S. interest rates by a half-percentage point to 0.5 percent at its next scheduled meeting on December 15-16. It is also expected to discuss what other policy tools could be used, and Bernanke’s speech was seen as a game plan for likely next steps.

At 0.5 percent, the overnight federal funds would be the lowest on records that date back to mid-1958. Bets on a zero rate by January are also increasing.

“While (the Fed) could lower rates a little bit more, the fact is that if we have to do more, most of it is going to come in the form of something other than just straight interest rate cuts,” said Stephen Stanley, chief economist at RBS Greenwich Capital in Greenwich, Connecticut.

In calling for vigorous action to support the economy, Bernanke said the economy was likely to be sluggish for some time. “The likely duration of the financial turmoil is difficult to judge, and thus the uncertainty surrounding the economic outlook is unusually large. But even if the functioning of financial markets continues to improve, economic conditions will probably remain weak for a time,” he said.

But he said there was no comparison between the current downturn — already the third-longest since the 1930s — and the Great Depression, when the U.S. economy contracted for over a decade, one in four U.S. workers was unemployed and bank failures were rampant.

“Let’s put that out of our minds. There is no comparison in terms of severity.”

Bernanke drew a distinction between the aggressive actions he and his colleagues have taken and blunders by the 1930s-era Fed, including excessively tight monetary policy and inaction as the financial system collapsed. He said he was being guided in part by his reading of history.

“I made my own mistakes, but I don’t want to make someone else’s mistakes,” he said.

(Writing by Ros Krasny and Alister Bull; Editing by Dan Grebler)

Latin America and the Global Slowdown: Key Outcomes from the World Economic Climate Index

RGE Monitor: Italo Lombardi y Vitoria Saddi | Nov 29, 2008

 

The CESifo recently released their World Economic Survey (WES). In this piece we summarize the main results of that publication with emphasis in the key outcomes for the Latin America region. The main results of the report are interesting especially because it allow us to compare the economic climate among the main regions of the world. The fact that the results are standardized allows us to compare the regions without further bias.

Friedman’s euro crisis is proving to be improbable

Many euro skeptics have argued that the worst is yet to come, but given recent events, it is now they who bear the burden of proof

Por: Barry Eichengreen

Taipei Times: Monday, Dec 01, 2008, Page 9

The global financial crisis has breathed new life into hoary arguments about the euro’s imminent demise. Such arguments often invoke Milton Friedman, who warned in 1998 that Europe’s commitment to the euro would be tested by the first serious economic downturn. That downturn is now upon us, but the results have been precisely the opposite of what Friedman predicted.

Unemployment is rising — and with it populist posturing. In countries like Italy, already suffering from Chinese competition, and Spain, which is experiencing a massive housing bust, the pain will be excruciating. Yet neither country shows any inclination to abandon the euro.

They understand that even whispering about that possibility would panic investors. They see how countries like Denmark that maintained their own currencies have been forced to raise interest rates to defend their exchange rates when the US Federal Reserve and the European Central Bank are cutting interest rates. They see how, if there was still a lira or a peseta, they would be experiencing capital flight. They understand that they would have to fend off an old-fashioned currency crisis at the worst possible time. They appreciate that there is stability and security in numbers.

Similarly, the euro-collapse scenario in which such countries successfully pressure the European Central Bank (ECB) to inflate, compelling Germany to abandon the euro, has shown no signs of developing. The ECB, protected by statutory independence and a price-stability mandate, has shown no inclination to accede to pressure from French President Nicolas Sarkozy or anyone else.

One can argue that the worst is yet to come — that there will be more inflation and unemployment down the road — and that, when they come, the euro area will collapse. Euro skeptics always make this argument. But, given recent events, it is now they who bear the burden of proof.

What neither Friedman nor anyone else anticipated in 1998 was that the first serious downturn following the advent of the euro would coincide with the mother of all financial crises. Runs by panicked investors have required central banks to undertake unprecedented lender-of-last-resort operations. Extensive loan losses have required expensive bank recapitalization operations.

There have been predictions that governments stretched to the limit by the financial crisis might respond by abandoning the euro. They might resort to the inflation tax and inject the national currency to restore liquidity to their banking systems and financial markets.

In fact, the response has been the opposite. The ECB has provided essentially unlimited amounts of liquidity to euro-area financial systems. The Stability and Growth Pact has been relaxed in order to increase governments’ capacity to borrow to recapitalize their banks.

It is European countries outside the euro area, still with their own currencies, that have suffered the gravest difficulties. Because their currencies are not widely used internationally, many of their bank liabilities are in euros. This renders them dependent on interest rate hikes to attract — via the market and on swap lines from the ECB — the euro liquidity that their banks desperately need. So far, those swaps have been forthcoming, but with delay and political baggage attached.

The implication is clear. National banking systems need a lender of last resort. In small countries, where a significant share of bank liabilities is in someone else’s currency, the national central bank lacks this capacity. The only options are then to slap draconian controls on the banking system or join the euro area.

Given the difficulty of rolling back the financial clock and the constraints of the Single Market, it is clear which way European countries will move. One already sees a shift in public opinion toward euro adoption in Denmark and Sweden. Poland has reiterated its commitment to adopting the euro. Hungary is certain to do likewise.

Obviously, the crisis will be economically and financial challenging for Eastern Europe. It will heighten the difficulty of meeting the convergence criteria for euro adoption. But it will also heighten the will to succeed.

The implication, then, is a larger euro area, not a smaller one, as more countries see the writing on the wall. Indeed, there are already signs of countries not even in the EU, notably Iceland and Switzerland, contemplating accession as a step toward adopting the euro and resolving their financial dilemma.

The one exception is probably Britain, whose currency is used internationally as a legacy of its history. In any case, Britain has always had one foot in Europe and one foot out. It is conceivable, therefore, that Europe will have two currencies, the euro and sterling, in the long run. But having three currencies, much less three dozen, is out of the question.

Barry Eichengreen is professor of economics at the University of California, Berkeley.
COPYRIGHT: PROJECT SYNDICATE

Oil sinks after Opec fails to cut output

By Javier Blas, Commodities Correspondent

Financial Times: December 1 2008

Oil prices fell sharply on Monday, approaching the $50 a barrel level, after Opec delayed a production cut until mid-December after a meeting over the weekend in Cairo.

The oil cartel, which controls 40 per cent of the world’s production, said oil demand was weakening fast, but agreed to wait until a meeting in Oran, Algeria, on December 17 to reduce further its output.

Abdalla El-Badri, Opec’s secretary-general, said on Saturday there was “general consensus for action in December”.

Ed Meir, of MF Global in New York, said that despite knowing full well that the oil markets are over-supplied, Opec decided to pass on making any quota cuts at its weekend meeting in Cairo.

“Apparently, Gulf producers insisted on stricter compliance of existing cuts before new ones were introduced,” Mr Meir said.

The cartel has promised to lower its production by 2m barrels a day in the last two months, but analysts said it has cut about 1-1.2m b/d so far.

In morning trading in London, Nymex January West Texas Intermediate fell $2.52 to $51.91 a barrel while ICE January Brent fell $2.54 to $50.95 a barrel.

Some Opec countries, such as Iran and Venezuela, had indicated they would support a cut of 1m-1.5m b/d at the meeting in Oran.

The drop in prices came in spite of King Abdullah of Saudi Arabia, world’s largest oil producer, signal over the weekend that he wanted oil prices to rise back to $75 a barrel from their current of about $50 level.

Olivier Jakob, of oil consultancy Petromatrix, said that the fact that Saudi Arabia is back to mention a fair price marks a significant departure from the previously held line that the price is set by the market.

Mr Jakob added: “If the King wants crude oil to be at $75 a barrel, the words need to be followed by action and this weekend gathering of Opec ministers did not provide any new signs of that.”

“This was Opec at its worse and clearly a weekend not of Thanksgiving but of misgiving.”

Base metals were mostly higher following a report that China will buy about $3bn worth of tin, copper, aluminium, lead and zinc. China’s Yunnan province will buy 1 million tonnes of base metals to help smelters in the region that are struggling with weak domestic demand and low prices, Reuters said quoting a report on the Chinese Ministry of Land and Resources’ website on Monday.

On the London Metal Exchange, tin prices surged briefly 10 per cent on the news that Yunnan province will buy 100,000 tonnes of the metal – equal to about a quarter of the world’s output – but prices later pared gains amid doubts about the report. In morning trading, tin was up 0.4 per cent to $12,500 a tonne.

Copper was 1.1 per cent higher to $3,700 a tonne while zinc and lead posted gains of about 1 per cent. Aluminium was flat at $1,776 a tonne.

Agricultural commodities were mixed, with wheat, corn and soyabean down and sugar, cocoa and coffee up.

Copyright The Financial Times Limited 2008

The greatness of Keynes …

Conscience of a Liberal: November 30, 2008, 1:05 pm

… is illustrated by the trouble people who consider themselves well informed have, to this day, in understanding the basic principles of how a depressed economy works.

The key to Keynes’s contribution was his realization that liquidity preference — the desire of individuals to hold liquid monetary assets — can lead to situations in which effective demand isn’t enough to employ all the economy’s resources. When you don’t understand that principle, you end up writing stuff like this:

Obama’s “rescue plan for the middle class” includes a tax credit for businesses “for each new employee they hire” in America over the next two years. The assumption is that businesses will create jobs that would not have been created without the subsidy. If so, the subsidy will suffuse the economy with inefficiencies — labor costs not justified by value added.

That is, if the private sector wouldn’t have created a job on its own, that job shouldn’t have been created — whereas the real choice is between having workers doing something and being uselessly, destructively unemployed.

From the same article, we have this:

In a forthcoming paper, Ohanian argues that “much of the depth of the Depression” is explained by Hoover’s policy — a precursor of the New Deal mentality — of pressuring businesses to keep nominal wages fixed.

I’ve already pointed out how Keynes disposed of the money-wage argument, way back in 1936.

Why do people still fail to get Keynes, after all these years? Keynes might have said that it’s the inherent difficulty of the concepts:

For—though no one will believe it—economics is a technical and difficult subject.

But there’s also the Upton Sinclair theorem:

It is difficult to get a man to understand something, when his salary depends upon his not understanding it.

The Keynesian moment

Conscience of a Liberal: November 29, 2008, 12:03 pm

Greg has this exactly right:

IF you were going to turn to only one economist to understand the problems facing the economy, there is little doubt that the economist would be John Maynard Keynes. Although Keynes died more than a half-century ago, his diagnosis of recessions and depressions remains the foundation of modern macroeconomics. His insights go a long way toward explaining the challenges we now confront.

I think it’s worth saying a bit more about why, exactly, we’re in such a Keynesian moment.

If Keynes receded in our consciousness over the past few decades, it wasn’t mainly because of uninformed criticisms from the right; it was because central bankers seemed to have everything under control. Uncle Alan and his counterparts, by controlling the money supply, could do the job of stabilizing the economy, and Keynesian fiscal policy seemed irrelevant.

Now, Keynes understood the role of monetary policy quite well, and believed that it had been effective in the past. What he argued, however, was that there were situations in which monetary policy could do no more — and that the world economy he lived in was facing such a situation:

To-day and presumably for the future the schedule of the marginal efficiency of capital is, for a variety of reasons, much lower than it was in the nineteenth century. The acuteness and the peculiarity of our contemporary problem arises, therefore, out of the possibility that the average rate of interest which will allow a reasonable average level of employment is one so unacceptable to wealth-owners that it cannot be readily established merely by manipulating the quantity of money. So long as a tolerable level of employment could be attained on the average of one or two or three decades merely by assuring an adequate supply of money in terms of wage-units, even the nineteenth century could find a way. If this was our only problem now—if a sufficient degree of devaluation is all we need—we, to-day, would certainly find a way.

Archaic language, but he was describing a situation very much like the one we face now.

To be sure, Keynes failed to foresee the postwar rise of the “marginal efficiency of capital” — the way that economic growth combined with inflation would create an environment in which interest rates were high enough in normal times that monetary policy was effective at fighting slumps. Hence the long era in which Keynes didn’t seem all that relevant. But his analysis remained as valid as ever, under the right conditions. Those conditions reappeared first in Japan during the 90s; now they’re everywhere.

And in the long run, it turns out, Keynes is anything but dead.

Deficits and the Future

By PAUL KRUGMAN

New York Times: December 1, 2008

Right now there’s intense debate about how aggressive the United States government should be in its attempts to turn the economy around. Many economists, myself included, are calling for a very large fiscal expansion to keep the economy from going into free fall. Others, however, worry about the burden that large budget deficits will place on future generations.

But the deficit worriers have it all wrong. Under current conditions, there’s no trade-off between what’s good in the short run and what’s good for the long run; strong fiscal expansion would actually enhance the economy’s long-run prospects.

The claim that budget deficits make the economy poorer in the long run is based on the belief that government borrowing “crowds out” private investment — that the government, by issuing lots of debt, drives up interest rates, which makes businesses unwilling to spend on new plant and equipment, and that this in turn reduces the economy’s long-run rate of growth. Under normal circumstances there’s a lot to this argument.

But circumstances right now are anything but normal. Consider what would happen next year if the Obama administration gave in to the deficit hawks and scaled back its fiscal plans.

Would this lead to lower interest rates? It certainly wouldn’t lead to a reduction in short-term interest rates, which are more or less controlled by the Federal Reserve. The Fed is already keeping those rates as low as it can — virtually at zero — and won’t change that policy unless it sees signs that the economy is threatening to overheat. And that doesn’t seem like a realistic prospect any time soon.

What about longer-term rates? These rates, which are already at a half-century low, mainly reflect expected future short-term rates. Fiscal austerity could push them even lower — but only by creating expectations that the economy would remain deeply depressed for a long time, which would reduce, not increase, private investment.

The idea that tight fiscal policy when the economy is depressed actually reduces private investment isn’t just a hypothetical argument: it’s exactly what happened in two important episodes in history.

The first took place in 1937, when Franklin Roosevelt mistakenly heeded the advice of his own era’s deficit worriers. He sharply reduced government spending, among other things cutting the Works Progress Administration in half, and also raised taxes. The result was a severe recession, and a steep fall in private investment.

The second episode took place 60 years later, in Japan. In 1996-97 the Japanese government tried to balance its budget, cutting spending and raising taxes. And again the recession that followed led to a steep fall in private investment.

Just to be clear, I’m not arguing that trying to reduce the budget deficit is always bad for private investment. You can make a reasonable case that Bill Clinton’s fiscal restraint in the 1990s helped fuel the great U.S. investment boom of that decade, which in turn helped cause a resurgence in productivity growth.

What made fiscal austerity such a bad idea both in Roosevelt’s America and in 1990s Japan were special circumstances: in both cases the government pulled back in the face of a liquidity trap, a situation in which the monetary authority had cut interest rates as far as it could, yet the economy was still operating far below capacity.

And we’re in the same kind of trap today — which is why deficit worries are misplaced.

One more thing: Fiscal expansion will be even better for America’s future if a large part of the expansion takes the form of public investment — of building roads, repairing bridges and developing new technologies, all of which make the nation richer in the long run.

Should the government have a permanent policy of running large budget deficits? Of course not. Although public debt isn’t as bad a thing as many people believe — it’s basically money we owe to ourselves — in the long run the government, like private individuals, has to match its spending to its income.

But right now we have a fundamental shortfall in private spending: consumers are rediscovering the virtues of saving at the same moment that businesses, burned by past excesses and hamstrung by the troubles of the financial system, are cutting back on investment. That gap will eventually close, but until it does, government spending must take up the slack. Otherwise, private investment, and the economy as a whole, will plunge even more.

The bottom line, then, is that people who think that fiscal expansion today is bad for future generations have got it exactly wrong. The best course of action, both for today’s workers and for their children, is to do whatever it takes to get this economy on the road to recovery.

A version of this article appeared in print on December 1, 2008, on page A29 of the New York edition.

Lest We Forget (por miedo a olvidar)

By PAUL KRUGMAN

New York Times: November 27, 2008

A few months ago I found myself at a meeting of economists and finance officials, discussing — what else? — the crisis. There was a lot of soul-searching going on. One senior policy maker asked, “Why didn’t we see this coming?”

There was, of course, only one thing to say in reply, so I said it: “What do you mean ‘we,’ white man?”

Seriously, though, the official had a point. Some people say that the current crisis is unprecedented, but the truth is that there were plenty of precedents, some of them of very recent vintage. Yet these precedents were ignored. And the story of how “we” failed to see this coming has a clear policy implication — namely, that financial market reform should be pressed quickly, that it shouldn’t wait until the crisis is resolved.

About those precedents: Why did so many observers dismiss the obvious signs of a housing bubble, even though the 1990s dot-com bubble was fresh in our memories?

Why did so many people insist that our financial system was “resilient,” as Alan Greenspan put it, when in 1998 the collapse of a single hedge fund, Long-Term Capital Management, temporarily paralyzed credit markets around the world?

Why did almost everyone believe in the omnipotence of the Federal Reserve when its counterpart, the Bank of Japan, spent a decade trying and failing to jump-start a stalled economy?

One answer to these questions is that nobody likes a party pooper. While the housing bubble was still inflating, lenders were making lots of money issuing mortgages to anyone who walked in the door; investment banks were making even more money repackaging those mortgages into shiny new securities; and money managers who booked big paper profits by buying those securities with borrowed funds looked like geniuses, and were paid accordingly. Who wanted to hear from dismal economists warning that the whole thing was, in effect, a giant Ponzi scheme?

There’s also another reason the economic policy establishment failed to see the current crisis coming. The crises of the 1990s and the early years of this decade should have been seen as dire omens, as intimations of still worse troubles to come. But everyone was too busy celebrating our success in getting through those crises to notice.

Consider, in particular, what happened after the crisis of 1997-98. This crisis showed that the modern financial system, with its deregulated markets, highly leveraged players and global capital flows, was becoming dangerously fragile. But when the crisis abated, the order of the day was triumphalism, not soul-searching.

Time magazine famously named Mr. Greenspan, Robert Rubin and Lawrence Summers “The Committee to Save the World” — the “Three Marketeers” who “prevented a global meltdown.” In effect, everyone declared a victory party over our pullback from the brink, while forgetting to ask how we got so close to the brink in the first place.

In fact, both the crisis of 1997-98 and the bursting of the dot-com bubble probably had the perverse effect of making both investors and public officials more, not less, complacent. Because neither crisis quite lived up to our worst fears, because neither brought about another Great Depression, investors came to believe that Mr. Greenspan had the magical power to solve all problems — and so, one suspects, did Mr. Greenspan himself, who opposed all proposals for prudential regulation of the financial system.

Now we’re in the midst of another crisis, the worst since the 1930s. For the moment, all eyes are on the immediate response to that crisis. Will the Fed’s ever more aggressive efforts to unfreeze the credit markets finally start getting somewhere? Will the Obama administration’s fiscal stimulus turn output and employment around? (I’m still not sure, by the way, whether the economic team is thinking big enough.)

And because we’re all so worried about the current crisis, it’s hard to focus on the longer-term issues — on reining in our out-of-control financial system, so as to prevent or at least limit the next crisis. Yet the experience of the last decade suggests that we should be worrying about financial reform, above all regulating the “shadow banking system” at the heart of the current mess, sooner rather than later.

For once the economy is on the road to recovery, the wheeler-dealers will be making easy money again — and will lobby hard against anyone who tries to limit their bottom lines. Moreover, the success of recovery efforts will come to seem preordained, even though it wasn’t, and the urgency of action will be lost.

So here’s my plea: even though the incoming administration’s agenda is already very full, it should not put off financial reform. The time to start preventing the next crisis is now.

A version of this article appeared in print on November 28, 2008, on page A43 of the New York edition.