Crisis vs. Crisis

Opinion | Margaret Childs | April 2012

Ben Bernanke testifying

American policy makers have often criticised European leaders for being slow to react to the debt crisis. But on 21 March, Federal Reserve Chairman Ben Bernake saw a shift, telling the House of Representatives that "financial stresses in Europe have lessened, which has contributed to an improved tone of financial markets around the world, including in the United States."

Europeans were wary of the measures the Federal Reserve took during the 2008 U.S. sub-prime mortgage crisis. In 2010, the Austrian daily Die Presse wrote that the "quantitative easing" practiced by the Federal Reserve "heightens the risk of inflation." The liquidity tool only works if the money is taken back out of circulation once the "easing" bears fruit, the article explained. This never happened.

Of course, the Fed and the European Central Bank (ECB) are very different. The Fed’s mandate is price stability as well as full employment, making it easy to justify large injections of cash into the U.S. economy.  The ECB has regulations forbidding direct funding to national governments.

ECB head Mario Draghi is being applauded by some for the tactics behind his Long-Term Refinancing Operations (LTRO): a loan of €1 trillion to European banks at 1% for three years – money that can be re-loaned at a higher interest rate. Others say he’s just sidestepping ECB regulations.

Treasury Secretary Timothy Geithner took a more bullish tone, telling the House of Representatives that the U.S. was in a "much stronger position than the [European] continent as a whole," and that it had a better growth outlook because it had been "much more aggressive" in responding to its financial crisis.

If immediate growth is the goal, Europe is lagging behind, but if the U.S. and the EU want to give banks an incentive to be more responsible, Draghi may have made the better move.

By giving banks the security (and incentive) to loan to the public and to governments, the ECB is anticipating the economy’s recovery. If they don’t, Europe will be back to square one.

So, is it better to create quick liquidity without obligations or to bypass the regulations and use banks as an intermediary lender – with strings attached?


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