Governments need to be ready to use public funds to prop up struggling financial markets, a senior International Monetary Fund official said on Wednesday, acknowledging that monetary policy may be less effective in the current credit turmoil.
It is the closest the IMF has come to recommending that governments be prepared to step in beyond current measures that central banks are using to add liquidity to ease stressed credit markets. However, IMF First Deputy Managing Director John Lipsky, maintained he was not advocating a bailout. “We must keep all options on the table, including the potential use of public funds to safeguard the financial system,” Lipsky said in a speech to the Peterson Institute for International Economics in Washington. “While I am not advocating the use of taxpayer funds for individual banks, I fully recognize an appropriate role for public sector intervention after market solutions have been exhausted.”
The IMF also stood ready to use its funds, if needed, to help countries cushion the blow but for now was working with other global institutions, such as the Financial Stability Forum, to develop measures to repair the financial system. Asked later to elaborate on the use of public funds, Lipsky said: “The idea may be appropriate to think in terms of more direct support for the global financial system in a way that would be effective and consistent.”
The Federal Reserve and four other central banks on Tuesday vowed to pump fresh funds into cash-starved credit markets. Tightening credit conditions, sparked by the US subprime mortgage housing meltdown, have threatened the global economy. The Fed expanded its securities lending program on Tuesday by offering up to $200 billion of highly liquid US Treasuries to primary dealers and widening the types of securities that can be used as collateral for the loans. Effectively, it allows banks to exchange unwanted mortgage notes for easy-to-sell government securities. After seven months of credit turmoil, Lipsky said there was little doubt that risks could escalate and decisive policy action was needed.
The first priority, he said, was to restore the normal functioning of financial markets and steps are needed to make sure banks are adequately capitalized while also increasing their transparency. “Even as these financial sector policies take hold, the global economy-- and advanced economies in particular –will continue to face pressures from tightening credit conditions,” he said. “If so, there is likely to be a role in some countries for stepped-up counter-cyclical macroeconomic policy measures to help support demand.” He said monetary policy alone may not be enough, and all options -- including the use of public funds -- should be considered.
THINK THE UNTHINKABLE
“Policy makers as a matter of course need to ‘think the unthinkable,’ and to consider how they would plan to react if contingencies arise,” he said. “The need to prepare more systematically for potential risks has been demonstrated amply during the past few months.” Lipsky said Tuesday’s coordinated efforts by world central banks to unclog financial markets were “helpful,” but monetary policy may be less effective in the current crisis and countries should consider temporary fiscal measures. “In the United States, where growth has slowed significantly, the temporary and targeted fiscal stimulus should help support demand,” he said. “Of course, the rest of the world will not be immune to the slowdown in the United States, especially if it becomes serious.
In these circumstances, contingency planning is also required...we are advising our members to consider whether they have room to adopt temporary fiscal measures, if needed.” He said the current turmoil underscored the need to identify “contingent risks” that could threaten global stability. He said borrowing costs in the United States remained stubbornly high even after Fed interest rate cuts. He said the US central bank had acted “appropriately.” The European Central Bank, which has kept rates on hold because of concerns about steep inflation, could respond “flexibly if downside risks to growth intensify and inflation risks decline,” Lipsky said. (Reuters)