Day: December 8, 2008

To Lend or Not To Lend, Fed Edition

This is so brilliant I’m going to just copy Mark Thoma’s entire post right here:

Tim Duy emails:

Discordant headlines in Bloomberg:

Fed’s Kohn Says Regulators Should Encourage More Bank Lending Amid Turmoil: U.S. regulators should rise to the “challenge” of encouraging an expansion in bank lending amid a weakening economy and continuing financial-market turmoil, Federal Reserve Vice Chairman Donald Kohn said.

Fed’s Kroszner Urges Banks to Increase Capital Reserves to Buffer Losses: Federal Reserve Governor Randall Kroszner urged banks to hold more reserve capital to protect themselves from future “cascading losses,” as potential market fixes are “no guarantee” against another credit crisis.

It’s nice to see the Fed getting its communication problems under control.

This is the inconsistency I pointed out in the goals of the financial sector bailout. Banks need new capital to protect themselves against falling values of their existing assets. But if they use the new capital to make new loans, you defeat the purpose of the new capital, because that new capital is no longer helping support the existing assets. These are two separate and somewhat contradictory goals. Note that, according to Bloomberg (see the second link above), financial institutions have taken $978 billion in writedowns – so far – and raised only $872 billion in new capital. So while politicians rail against banks that took TARP money but haven’t expanded lending, the banks at least have logic on their side. I’ve been surprised that no one in Washington that I’m aware of has been willing to point this out.

(And do visit Mark’s blog – it’s a great place to get a variety of perspectives, updated throughout the day.)

Global Fiscal Stimulus: Will This Save Weaker Eurozone Countries?

Finally, the global economic policy ship begins to turn.  We are now seeing fiscal stimulus package announcements every week, if not every day.  And packages that we previously knew about are re-announced for emphasis and with an expanded mandate.  In all likelihood, we are looking at a fiscal stimulus in the order of 1-2 percent of world GDP, which is exactly what the IMF has been calling for.  Is this a modern miracle of international policy coordination?

The problem is – the IMF started calling for this in January 2008 when, with the benefit of hindsight, it would really have made a difference.  Fiscal policy is slow.  Even when everyone wants to move fast, when you can get the legislation through right away, and when there are “ready to go” projects, infrastructure spending will take at least 6-9 months to have perceptible effects in most economies. 

In the US we have some additional ways to boost spending, most notably as support to local and state governments, extending food stamps and the like (see my recent testimony to the Senate Budget Committee for further illustrations), and in most other countries that kind of government activity comes by way of “automatic stabilizers,” i.e., it happens without discretionary packages of the kinds that make headlines.  Still, the general point holds – the big fiscal stimulus package you put in place today is a bet on how the economy will be doing in a year or so.  And a year ago would have been a good time to start – remember that the NBER has just determined that the US recession actually started in December 2007 (but they were able to make the call only now, demonstrating how hard it is to forecast the present, let alone the future.)

My concern today, however, is not about the appropriateness of the overall package in the US, China or other emerging markets – in a crisis, erring on the side of “too much, too late” is better than “too little, too little.”  The problem is that in Europe we need not just a general fiscal stimulus (and more interest rate cuts), but also specific targeted measures that will provide appropriate, largely unconditional support to governments with weaker balance sheets (read: Greece, Ireland, Italy, but don’t exclude others from consideration). 

Monetary policy was consolidated in Europe (i.e., there is one currency for the eurozone) but fiscal policy substantially was not.  This imbalance is going to be addressed, one way or another, and perhaps under great stress.  Much progress has been made towards sensible policies in the US and some parts of Europe over the past two months, and calamity can still be avoided.  Let us not fall at the final hurdle.

Update: I talked with Madeleine Brand of NPR about some of these issues earlier today; audio recording and transcript are here.