Among all the confusion of the global financial crisis, one thing is becoming clear. There are major differences among the central banks which will be tested by the current crisis. The results of this test will influence the conduct of governments and their relation to market economies for many years to come.
On one side we have the aggressive strategy of the USA and UK central banks. At the other extreme we have the conservative strategy of the European Central Bank (ECB) and more specifically, the German economic policies which heavily influence that institution.
The US and UK central banks have of course lowered interest rates more rapidly and to lower levels than those of the ECB. But they have also been innovative, leading the ways beyond traditional monetary mechanisms.
The Federal Reserve in particular has lowered interest rates to virtually zero (from 0-.25%). The UK’s Bank of England is not far behind, lowering interest rates to the lowest level in several hundred years. Both banks have also engaged in innovative methods of supporting their markets. They have become equity investors in financial and non financial organizations (the automobile industry), direct financial support to mortgage holders, mortgage restructuring. Quantitative easing (putting money into the economy) has been used on an unprecedented scale.
The ECB, on the other hand, has maintained its traditional conservatism. It too has lowered interest rates and intervened in bolstering financial markets and institutions. The difference is mainly one of speed and scale but nevertheless reflecting major differences in their interpretation of the best way to tackle the crisis.
A difference in priorities
The roots of the discrepancy are to be found in the different priorities of these institutions. The ECB, heavily influenced by Germany, has voiced more than once its main priority is on defending markets against inflation. Germany has repeatedly criticized the Anglo-American level of government spending to fight the crisis.
The German Chancellor, Angela Merkel, has said: “We will not take part in a competition to outdo one another with an endless list of new proposals in a senseless contest over billions”.
Nevertheless, Germany has followed this statement with commitment of more billions to fight the crisis.
The US/UK governments have broader objectives – they too profess commitment to fighting inflation. But their actions indicate their main objective is a satisfactory level of economic activity and particularly employment. Their reasoning is that the first priority is to put out what they perceive to be a fire (recession) – even if the water poured into the blaze may cause some future damage (inflation). Who is right will be determined a number of years from now. The test will not be confined to overcoming the current crisis but also avoiding a future crisis and particularly inflation.
We may depend on it that the successful strategy will be the one which influences central bank behaviour and the role of government for many years to come. Should the Anglo-American approach prove more effective, the role of government, particularly in areas related to finance will be much more pro-active. Secondly, there will be an examination of the specific tools which have succeeded or failed. It is clear that today there is a good deal of guesswork as to which of the many measures will actually work. Thirdly, we may expect the introduction of new regulations and practices, particularly as regards mortgage lending and securitization.
Market economies will survive
None of the above means that the present market system will be threatened. It is well to keep in mind that during the great depression of the 1930’s both the crisis as well as the measures to correct it were more drastic than anything which has been seen or contemplated today. American unemployment then reached 25% (versus 7+ today). All banks were closed for a time, social security was introduced, labour legislation was revised. So many new government-owned and operated enterprises were introduced, designated by acronyms, that they were referred to as “alphabet soup”. Yet, the market system survived.
Change there will be, particularly in regulations aimed at preventing “overborrowing”, the real culprit behind the crisis.
Here in Cyprus, we remain up to this point better off than many of the more so-called developed economies. Quite simply, we have lagged behind in the stampede to offer ever more liberal credit terms. While American and some European banks were offering mortgages equal to 100% and even 120% of the value of a house, our credit offerings have been more conservative. In fact they may prove to be more in line with future global credit regulations. Yes, Cyprus leads the world!
Financial Mirror – DR. JIM LEONTIADES,CIIM, The Cyprus Business School