The Financial Decelerator
Fed Chairman Bernanke has a strategy to stave off another depression, but he can't do it alone.
http://www.washingtonpost.com/wp-dyn/content/article/2008/10/09/AR2008100902440_pf.html
Friday, October 10, 2008; A18
A STUDENT of the Great Depression, Federal Reserve Chairman Ben S. Bernanke has a strong sense of what caused that calamitous crash, and of what central banks and other government institutions did, or failed to do, to keep it from getting worse. Central to Mr. Bernanke's analysis is the concept of a "financial accelerator." Roughly, this is the idea that a breakdown in the financial system, uncorrected by government, exacerbated what might have otherwise been a relatively mild drop in "real" production.
Applying this lesson, Mr. Bernanke's Fed, in concert with the Treasury and other government agencies, has been pouring liquidity into the system for the past year, with relatively less regard for the long-term balance sheet of the U.S. government. Fed lending to financial institutions now totals $800 billion, Mr. Bernanke said Tuesday. That's not counting past interest rate cuts, the Fed's new plan to buy short-term commercial paper, or the Treasury's $200 billion seizure of Fannie Mae and Freddie Mac -- or the $700 billion rescue plan for distressed financial assets.
This raises a difficult question: At what point, precisely, will it become safe for the Fed to turn off the liquidity tap? But that question must wait for another day. Unless the Fed can engineer a gentle splashdown for the economy, the system could crash so hard that repaying today's emergency borrowing would be the least of our worries. Of course, that assumes that even the wisest policies can prove effective. The International Monetary Fund's gloomy forecast for the first half of next year -- zero or slightly negative growth in the developed world -- is actually relatively optimistic, in that it does assume policy success.
Certainly, we can't accuse Mr. Bernanke of insufficient effort. On Wednesday, he threw yet more liquidity at the problem, in the form of a half-percentage-point cut in the Fed's key interest rate. The novelty this time -- and it was a welcome one -- is that he acted in concert with the central banks of other countries, notably the European Central Bank, which had previously made inflation-fighting its top priority. But with Europe's banking system tottering, the ECB changed course, raising hopes for much-needed continued international policy coordination.
The first opportunity to extend and deepen that coordination comes at an international meeting of finance ministers and central bankers in Washington, beginning today. The mood will be grim, befitting a crisis that Mr. Bernanke has labeled "historic." We hope that, despite understandable feelings in some European countries, the meeting will not turn vindictive with respect to the United States.
Yes, the current crisis can be traced to America, thanks to a combination of unwise monetary and regulatory policies that facilitated the subprime mortgage bubble. The root cause, though, lies in the global glut of savings -- the piles of foreign exchange earnings that exporters such as China and the oil-producing states of the Persian Gulf accumulated and then recycled through the financial systems of the developed world. There were no effective international mechanisms for recognizing and managing the risks created by what was, in hindsight, too much easy money. It's good that governments seem to be getting together to deal with today's crisis. Soon, they will have to start devising ways of preventing the next one.
© 2008 The Washington Post Company
