Gloom Settles on Central Bankers

The Wall Street Journal

By JON HILSENRATH

JACKSON HOLE, Wyo.—After years fighting crises and pumping money into the financial system, the world's central bankers are coming to grips with the realization that the global economy is still in a very dangerous place.

Their problem is compounded by the fact that for some—notably the Federal Reserve—there isn't much more they can do to spur the economy. They have already pushed short-term interest rates to near zero and tried other, unconventional measures. In Europe, three years into crisis, the banking system is exposed to highly indebted European governments like Greece and remains short of capital, many say.

The angst was underscored in a blunt speech Saturday by the International Monetary Fund's new managing director, Christine Lagarde, at the Fed's annual retreat here.

"We risk seeing the fragile recovery derailed," the former French finance minister said. Those risks have been aggravated, she said, by the public's sense that top policy makers aren't adequately addressing the problems they face. "We are in a dangerous new phase," she said.

Ms. Lagarde, though neither a central banker nor an economist, articulated a sense of worry that representatives from many major central banks expressed, mostly behind the scenes, during the two-day conference.

The IMF chief pointedly called on leaders of major central banks to keep interest-rate policies "highly accommodative," a reference to the European Central Bank, which has begun to raise rates.

She directed sterner words at politicians. Europe needs to bolster the capital in its banks and—along with the U.S.—needs to strike the delicate balance of reducing government debt in the long run without cutting so aggressively in the short run that damage is done to tenuous economic growth.

Her remarks could presage an effort by leaders of G-20 nations meeting in Cannes, France, in November to develop more aggressive responses to fiscal crises and the weak economy.

Ms. Lagarde's comments amplified a speech made by Fed Chairman Ben Bernanke, who scolded U.S. politicians for undermining public confidence during the messy debate over raising the U.S. debt limit. He also called for fiscal belt-tightening that wasn't too aggressive at first because the economy is so weak.

Coming weeks pose important challenges for financial markets. "I'm concerned about a risk of events this autumn," said Robert Zoellick, president of the World Bank.

Officials here were especially worried about several fraught negotiations in Europe. European parliaments need to approve an expansion of the powers of the European Financial Stability Facility, which is seen as critical to stabilizing strained government finances in Greece, Portugal and elsewhere. Leaders in Finland are demanding hefty collateral in return for their support of Greece. Other creditors are contemplating a debt exchange with the Greek government that could lead to more turmoil if it fails.

ECB President Jean-Claude Trichet sought to dispel worries that European banks could be threatened by a loss of short-term funding. Banks have ample assets to use as collateral for borrowing from the ECB, he said. Worries that they will become short of cash are "just plain wrong," he said.

The Fed is also in a tough spot. Mr. Bernanke said almost nothing in a speech Friday about what the Fed might do next to support tepid U.S. growth. He did point to a Sept. 20-21 policy meeting at which officials could take new actions.

The central bank's choices aren't appealing. The Fed could restart a bond-buying program, or take smaller steps, including shifting the portfolio of bonds it already holds toward securities with longer maturities to bring down longer-term interest rates. But each step comes with costs, and the benefits aren't seen as very great.

One risk is political. "As the central banks in advanced countries continue to pursue easy monetary policy and unconventionally easy monetary policy, the political pressure on central bankers to do more to help finance budget deficits may grow," said Haruyuki Toyama, the general manager of the Bank of Japan's U.S. branch.