World Economic Outlook According to Rogoff
Over the past several weeks we have seen central banks such as the Fed taking on more and more debt as major commercial institutions have come to them in search of life support. What is the outlook for these central banks, the bedrock on which our international economy rests ?
Here is what Kenneth Rogoff, presently Thomas D. Cabot Professor of Public Policy at Harvard, has to say about it.
Do Central Banks Have an Exit Strategy?
September 15, 2008
A year into the global financial crisis, several key central banks remain extraordinarily exposed to their countries’ shaky private financial sectors. So far, the strategy of maintaining banking systems on feeding tubes of taxpayer-guaranteed short-term credit has made sense. But eventually central banks must pull the plug. Otherwise they will end up in intensive care themselves as credit losses overwhelm their balance sheets.
The idea that the world’s largest economies are merely facing a short-term panic looks increasingly [unrealistic]. Instead, it is becoming apparent that, after a period of epic profits and growth, the financial industry now needs to undergo a period of consolidation and pruning. Weak banks must be allowed to fail or merge (with ordinary depositors being paid off by government insurance funds), so that strong banks can emerge with renewed vigor.
The United States Federal Reserve, the European Central Bank, and the Bank of England are particularly exposed. Collectively, they have extended hundreds of billions of dollars in short-term loans to both traditional banks and complex, unregulated “investment banks.” Many other central banks are nervously watching the situation, well aware that they may soon find themselves in the same position as the global economy continues to soften and default rates on all manner of debt continue to rise.
If central banks are faced with a massive hit to their balance sheets, it will not necessarily be the end of the world. It has happened before – for example, during the 1990’s financial crises. But history suggests that fixing a central bank’s balance sheet is never pleasant. Faced with credit losses, a central bank can either dig its way out through inflation or await recapitalization by taxpayers. Both solutions are extremely traumatic.
[Currently Thomas D. Cabot Professor of Public Policy at Harvard, prior to which he] served as Economic Counsellor and Director, Research Department of the International Monetary Fund from August 2001 to September 2003. He was previously a Professor in the Department of Economics at Harvard University and, before that, the Charles and Marie Robertson Professor of International Affairs at Princeton University. Early in his career, Rogoff served as an economist at the International Monetary Fund and also at the Board of Governors of the Federal Reserve System. He is an elected member of the American Academy of Arts and Science as well as the Econometric Society, and a former Guggenheim Fellow. Mr Rogoff received a B.A. from Yale University summa cum laude in 1975, and a Ph.D. in Economics from the Massachusetts Institute of Technology in 1980.
Mr. Rogoff has published extensively on policy issues in international finance, including exchange rates, international debt issues, and international monetary policy. Together with Maurice Obstfeld, he is co-author of the 1996 graduate text/treatise Foundations of International Macroeconomics.
Mr. Rogoff was awarded the life title of international grandmaster of chess by the World Chess Federation (FIDE) in 1978.