Interestingly enough, at yesterday’s meeting, US Federal Reserve at the same time declared that significant risks threaten the economic situation AND decided not to introduce a new programme for monetising the Federal deficit. If things are bad, then why not try to do something about it?
The only logical explanation is that Fed does not find that there is a lot that a further QE-programme could really do about the economic situation in the short term. We are still in a Keynesian liquidity trap, where zero interest rates have no effect on the demand for credit, and hence does not contribute to increase the economic activity. Fed Chairman Bernanke was clear about such issues at the Jackson Hole conference in late August: “economic policies that support robust economic growth in the long run are outside the province of the central bank”.
Instead he, and with him a number of other high profiled officials have lately been very clear that cleaning up the mess is a responsibility of the elected governments. IMF Chief Lagarde, World Bank Chief Zoellick, and several other central bankers from across the globe have issued statements that closely match Bernanke’s explanation at the same meeting:
“To allow the economy to grow at its full potential, policymakers must work to promote macroeconomic and financial stability; adopt effective tax, trade, and regulatory policies; foster the development of a skilled workforce; encourage productive investment, both private and public; and provide appropriate support for research and development and for the adoption of new technologies (...) Although the issue of fiscal sustainability must urgently be addressed, fiscal policymakers should not, as a consequence, disregard the fragility of the current economic recovery. Fortunately, the two goals of achieving fiscal sustainability--which is the result of responsible policies set in place for the longer term--and avoiding the creation of fiscal headwinds for the current recovery are not incompatible. Acting now to put in place a credible plan for reducing future deficits over the longer term, while being attentive to the implications of fiscal choices for the recovery in the near term, can help serve both objectives”.
And there is more: “Finally, and perhaps most challenging, the country would be well served by a better process for making fiscal decisions”.
There you have it: Fed does not feel that it can do an awful lot more. It is up to US lawmakers to pull up their socks and act in order to bring the economy back on an even keel.
However, the European sovereign crisis, the increase in the price of credit risk and the fear of having government debt downgraded have led to a resurgence in fiscal conservatism at the wrong moment. Simple recklessness on the part of US Republican lawmakers does not make it better. Just a few months ago, governments in the entire OECD area seemed bent on making things worse by introducing austerity programs. Since then, the sharp deceleration in economic growth and renewed market turmoil has led policy makers to ease the foot away from the brake, sort of.
It is perhaps symptomatic that the markets have lost confidence in politicians to a degree that central bankers’ statements are studied more closely than anything else. But Fed’s lack of action clearly indicates that there is not an awful lot more central bankers can do.
What next, then? With politicians constantly on the verge of committing major policy errors and central banks with only little dry powder left, what will create the growth the world so badly needs? It has been said before and I repeat: A period of sub-par growth while fiscal balances are redressed.
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