Bloomberg News

Central Bankers Urge Governments to Throw Economic Lifeline

August 29, 2011

(Updates markets in eighth paragraph.)

Aug. 29 (Bloomberg) -- Central bankers gathered at an annual retreat in Jackson Hole, Wyoming, this weekend had a message for political leaders: monetary policy alone can’t keep the global expansion going.

Federal Reserve Chairman Ben S. Bernanke urged adoption of “good, proactive housing policies” to reverse the depressed U.S. real estate market and warned lawmakers to avoid steps that may hurt short-term growth. Ewald Nowotny of the European Central Bank Governing Council said euro-area governments should expand the powers of their regional bailout fund.

“Most of the economic policies that support robust economic growth in the long run are outside the province of the central bank,” Bernanke said at the annual conference of policy makers and economists, sponsored by the Kansas City Fed.

The call to arms ended a month in which the Fed and the ECB raced to shield their economies from fiscal tightening and strengthen a world economy that is losing momentum. Reports this week may underscore the challenges faced by policy makers: U.S. payroll growth probably slowed in August, and confidence in Europe’s economy fell to its lowest since April 2010, economists forecast. Fed policy makers will meet for two days in September instead of one so they can discuss options for spurring growth.

Warning of a “dangerous new phase” for the world economy, International Monetary Fund Managing Director Christine Lagarde told the forum that risks have been aggravated by “a growing sense that policy makers do not have the conviction, or simply are not willing, to take the decisions that are needed.”

‘Twin Perils’

“Fiscal policy must navigate between the twin perils of losing credibility and undercutting recovery,” said Lagarde, who took the helm of the IMF in July.

Bernanke told the conference that the U.S. central bank still has a “range of tools” it could use to help the economy if needed, although he stopped short of signaling that the Fed would embark on a third round of government bond buying.

European stocks rose as investors awaited a report that may show U.S. consumer spending gained. The Stoxx Europe 600 Index, which last week dropped to near the cheapest valuation in more than two years, advanced 0.7 percent to 227.12 at 8:40 a.m. in London. Asian shares and U.S. index futures climbed. The U.K market is closed for a holiday today.

The Fed pledged on Aug. 9 to keep its main interest rate at a record low near zero through at least mid-2013. The ECB is taking the lead in combating a sovereign debt crisis approaching its third year by buying Spanish and Italian bonds.

‘Only Game in Town’

“It’s a difficult burden central banks are carrying because of the constraints of fiscal policy,” Diane Swonk, chief economist at Mesirow Financial Holdings Inc., said in an interview in Jackson Hole. “The Fed and other central banks realize they are the only game in town.”

The policy makers met for three days to discuss ways to bolster long-term economic performance. They gathered as banks from UBS AG to Citigroup Inc. cut their forecasts for global expansion and predicted the Fed, ECB and Bank of Japan will keep benchmark interest rates at or near record lows through 2012.

Recession Odds

Harvard University Professor Martin Feldstein, who attended the conference, told Bloomberg Television there are “better than even” odds of another U.S. recession, while Stanford University’s John Taylor called it a “recovery in name only.” Allen Sinai, president of Decision Economics, said the chance of a global slump is 30 percent.

The dilemma for policy makers is that four years to the month since the start of the global credit crisis they have fewer remedies to aid the faltering expansion. Government budget deficits are high and interest rates are already at or near record lows.

A paper presented at the conference by economists from the Bank for International Settlements concluded that governments start to impair economic growth when their debts reach about 80 percent to 100 percent of gross domestic product, levels now witnessed in all of the Group of Seven countries.

Kansas City Fed President Thomas Hoenig told Bloomberg Television that there is a limit to how much more the Fed can help the economy, saying, “we can’t do it all.”

Recovery ‘Fragility’

Standard & Poor’s downgraded the U.S. credit rating this month, even as U.S. politicians agreed Aug. 2 to slice the nation’s deficit by $2.4 trillion over 10 years. While urging politicians to control the nation’s long-term deficits, Bernanke said they should not “disregard the fragility of the current economic recovery.”

Congress must adopt a “credible plan for reducing future deficits over the longer term,” yet avoid policies which harm near-term growth, Bernanke said. President Barack Obama is preparing a post-Labor Day speech with plans for stimulating the economy.

The U.S. also needs new ways to turn around the depressed housing market and help ease foreclosures, Bernanke said. He called on Congress to develop a “better process for making fiscal decisions” after the drawn-out debate over raising the nation’s debt limit created turmoil in financial markets worldwide.

The Fed chief’s points were echoed by Lagarde, who said governments could free up cash for short-term spending by tackling long-term fiscal challenges such as expensive entitlements and health-care programs.

Housing Market

The U.S. could stop the slide in house prices perhaps by reducing the principal paid by homeowners or by making it easier for them to refinance mortgages at lower interest rates, Lagarde said. European banks should be forced to raise more capital, she said, with the goal of preventing the continent’s debt crisis from infecting more countries.

“While fiscal consolidation remains an imperative, macroeconomic policies must support growth,” Lagarde said.

Conference participants including Nowotny urged governments to accelerate their response to the spreading debt woes and relieve pressure on the ECB. The central bank needs to shore up markets as lawmakers take time ratifying a plan to increase the size of their rescue fund and allow it to buy bonds in markets and aid banks. The latest obstacle is Finland’s demand for collateral in return for aiding Greece.

“I am concerned by the delays we’ve seen in the political field,” Nowotny said in an interview. “Monetary policy cannot substitute for fiscal policy.”

Biggest Threat

Europe’s plight was a major talking point at the meeting, with former Mexican central bank Governor Guillermo Ortiz calling it the biggest threat to international growth. Harvard University Professor Dani Rodrik said on Twitter that “the fear about the euro zone was palpable” among delegates and that “no one has confidence in the current strategy.” Bernanke nevertheless expressed confidence officials would succeed “over time.”

Attending his final Jackson Hole conference before retiring Oct. 31 as the ECB’s president, Jean-Claude Trichet avoided any in-depth commentary on his economy’s current woes other than to say it wouldn’t suffer a “liquidity crisis” and that all advanced nations faced “formidable” challenges.

“There is still an enormous potential to tap to reform our economies and boost their growth potential and job creation,” Trichet said. He is scheduled to meet European lawmakers today in Brussels to discuss management of the crisis.

Speaking after Lagarde urged central banks to keep their policies accommodative, Trichet also reiterated that the ECB’s focus remains on delivering price stability, and he praised its control of inflation expectations. The ECB raised its key rate twice this year to 1.5 percent.

--With assistance from Mike McKee in Jackson Hole and Scott Lanman in Washington. Editors: James Tyson, Jim Rubin.

To contact the reporter on this story: Jeannine Aversa in Jackson Hole, Wyoming at javersa@bloomberg.net; Simon Kennedy in Jackson Hole at skennedy4@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net


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