Sep 18, 2013

    US Fed can only do so much

    The New York Times

    THE United States Federal Reserve remains the most powerful central bank in the world.

    Its policy actions reverberate in every corner of the globe, something no other central bank can claim. Even the hint of a "taper" - the withdrawal of easy-money policies - has roiled emerging markets.

    Given the global impact of the Fed's actions, the choice of a replacement for chairman Ben Bernanke is being watched with keen interest.

    Moreover, in the aftermath of the crisis, central banks have become even more important to economic management, taking on much of the burden of controlling inflation, improving financial stability and promoting growth.

    This is a difficult balancing act in the best of times. It becomes virtually impossible when fiscal and other policies are working at cross purposes.

    In the US, for instance, short-term fiscal tightening (along with the uncertainty associated with deficit and debt-ceiling negotiations that repeatedly go down to the wire) has hobbled the recovery.

    Meanwhile, little has been done to tackle the longer-term fiscal problems, especially entitlement spending.

    In India, the government has been unwilling to undertake politically unpopular reforms to tackle large budget deficits and structural problems such as stifling labour-market regulations. This has led to the makers of monetary policy having to do all the heavy lifting.

    The reliance on central banks to make up for the failings of other policies has created inevitable international tensions.

    The right monetary policy for one country might not necessarily be good for another. Unlike fiscal policies, whose effects tend to stay mostly domestic, monetary policies affect currency values and financial markets in other countries.

    Whoever takes over from Mr Bernanke, the reality is that the Fed chairman has a mandate to focus only on domestic objectives.

    Fair enough: No central bank in the world has anything but domestic objectives in its mandate. But when the Fed acts, it matters to the world in a way that no other central bank's actions do.

    In a report by a committee of academics and former central bankers in which I participated, we argued that the Fed and a small group of central banks from both advanced and emerging-market economies should hold regular meetings and issue a report on their monetary-policy intentions.

    Even if this procedure only exposes mutual inconsistencies in policy, it would still be a way to put pressure on politicians to stop relying on the crutch of monetary policy and prod them to take politically unpopular measures to improve productivity and the prospects of long-term growth while making global capital flows more stable.

    So, who would the rest of the world vote for to head the most important central bank?

    No matter who gets the job, what many of the world's central bankers are hoping for is a Fed that can go back to the more modest objectives of maintaining low inflation and financial stability.

    On that, at least, there is certainly international agreement.

    Dr Eswar Prasad is a professor of economics at Cornell University and a senior fellow at the Brookings Institution.