By Steven K. Beckner and Claudia Hirsch
NEW YORK (MNI) – Federal Reserve Board Gov. Kevin Warsh said Friday
the central bank has begun its exit from unprecedented financial rescue
efforts, given the conclusion of most of the special liquidity
facilities it created in the throes of financial crisis.
But Warsh differentiated between exiting from those facilities and
exiting from the Fed’s easy monetary policy.
As the Fed proceeds with its exit strategy, he said it is important
that the Fed do so in ways that are “understandable … credible and
predictable.”
Warsh, speaking extemporaneously as a panelist at a conference
sponsored by the Levy Economics Institute, said the economy is in a
“cyclical recovery,” but it remains unclear what the longer term trends
of growth and employment will be. He said that is something the Fed will
be trying to determine.
After going through a boom and then a panic, Warsh asked
rhetorically, “What stage are we in now?”
“I would say we are, in different forms, in an exit stage,” he said
in response to his own question.
“I wouldn’t say all policymakers everywhere around the world are in
the exit stage,” he continued, adding, “I wouldn’t say all policymakers
in the U.S. are convinced we are in an exit stage.”
Warsh said “exit is an important, useful discussion to be had.”
So far, he said the Fed “has done a reasonable job of” exiting from
its emergency anti-crisis operations.
Warsh said the Fed has “for quite some now (been) exploring the
exit, describing the exit from the liquidity facilities and
differentiating that from exit from our core monetary policy functions.”
Digressing, he said “the fiscal (authorities) would do themselves a
good service by also beginning a robust discussion of exit.” He said
that “would be confidence inducing” for financial markets.
Asked when the markets will think the Fed’s “exit” is “real,” Warsh
replied, “I’m afraid the answer depends on what exit means.”
Again noting that the Fed has largely closed its special liquidity
facilities — not including all aspects of the Term Asset-Backed
Securities Loan Facility — Warsh said, “by that definition exit is
really upon us.”
Warsh did not say when the Fed might start reducing the size of its
$2.3 trillion balance sheet, but observed, “When financial firm balance
sheets shrunk during the crisis … the Fed’s balance sheet expanded”
and acted as “a shock absorber.”
“When private financial firm balance sheets grow, then the Fed
balance sheet will shrink,” he added.
Citing improved capitalization of large financial firms, Warsh said
there are “encouraging signs” for firms’ balance sheets.
“I don’t think markets are waiting for all exits to be complete
before trying to figure out their place in the new financial
architecture,” Warsh went on.
“Progress has been made on ending some but not all of our
facilities,” he said. “It’s a trend I’d like to see continue, but it has
to continue in a way that is understandable … and is credible and
predictable.”
Warsh said “people are comfortable now with the central bank
talking about exit,” and he said the members of the Federal Open Market
Committee are continuing to deliberate on exit strategy.
“So long as we can adequately and concertedly explain what we’re
doing, why we’re doing it and what the triggers are for it, then the
exit can be completed in a way” that enables the economy and the
financial system to succeed.
Warsh’s comments on the economy were limited, but he said, the
economy is in “a cyclical recovery” although “the strength and duration
of it matters.”
“What matters is the growth rate over the horizon,” he said,
asking, “What is the trend growth rate of the economy after the cyclical
recovery has run its course. What is the unemployment rate or the
natural rate of unemployment once the cyclical recovery has run its
course?”
Warsh said “the economy is in some ways what banks and central
banks are trying to understand.”
He said the Fed is “trying to take soundings of the economy and
also trying to give direction to the economy.”
In other comments, Warsh said “there are reasonable calls for more
transparency,” such as providing more counterparty transaction data.
“But if the call is a euphemism for ending the central bank, I
think we become less comfortable,” he said.
Warsh said the Fed should retain its current regulatory powers over
large and small banks alike, and, importantly, its political
independence in crafting monetary policy, in whatever final financial
reform package becomes law. The new financial architecture, however,
remains “in flux,” he said.
Warsh favors a variety of financial institutions and banks when the
economy emerges on the other side, arguing that small banks, connected
to the nation’s small businesses, are uniquely important to the economy
as a whole.
A “managed oligopoly” of banks, such as in Canada, would be bad for
the economy, he said.
During the crisis, Warsh said the line between providing liquidity
and engaging in fiscal actions “blurred.”
Now, he said, “even though central banks can’t immediately go home
again, we do all we can to stay four square on the right side of that
line” — that is to limit itself to being lender of last resort and let
fiscal authorities “be the ultimate rescuers” and make the tough
political judgments.
** Market News International **
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