A mood of wary optimism – but no triumphalism – prevailed on the first day of the US Federal Reserve’s annual retreat for the world’s central bankers in the mountain resort of Jackson Hole, Wyoming.
Policymakers appeared more relaxed than they have for months as they exchanged views on the past year of crisis and the road ahead.There was widespread agreement that the worst of the crisis was over, and the risk of a descent into a second Great Depression – which seemed to threaten as recently as March – had greatly diminished if not disappeared. Yet there was little of the euphoria present in markets in recent weeks. Officials from the world’s leading central banks were relieved by a spate of generally positive economic data and the market rally, but not prepared to read too much into this.
While Ben Bernanke, the Fed chairman, made clear his belief that central bankers’ actions over the past year – including large-scale purchases of assets by the Federal Reserve and Bank of England, and provision of unlimited loans to banks by the European Central Bank – had helped to stabilise the world economy, no one was declaring mission accomplished.
In part, this was influenced by the uncertainty surrounding the chances of the reappointment of Mr Bernanke, whose tenure expires early next year.
While most of his peers think he has done a remarkable job in battling the crisis, the White House has been silent over his prospects for another term, with Larry Summers, the director of the National Economic Council, and Janet Yellen, the president of the San Francisco Fed, seen as potential alternatives.
The main reasons for the sober atmosphere, however, relate to central bankers’ perceptions of the state of the global economy and the challenges still ahead.
First, they see a long hard slog for the economy, despite recent hopeful news. They have not changed their view that weak consumer demand and strained household finances in the US and some other developed nations – coupled with continuing banking sector weakness – mean the recovery is likely to be weak for some time, with further rises in unemployment.
Stanley Fischer, governor of the Bank of Israel, said “growth does appear to be beginning to resume,” but he added that “despite the encouraging signs of recovery it is too early to declare the crisis over”.
Mr Fischer said “much remains to be done” to restore banking systems to health and there were good reasons ”to fear a sub-standard recovery”.
Policymakers are confident in the outlook for the second half of this year. But they have very little visibility for 2010, when some of the factors boosting current performance – including a replenishment of inventories and car-buying incentives – will fade.
They have only an imprecise sense of what the dynamics of growth will look like in a period of continued deleveraging by overstretched households, financial institutions and certain groups of companies (such as those refinanced through leveraged buyouts).
They see further pressure on banks ahead, including defaults on commercial property, and the prospect of failure of some smaller banks, even if not the systemically important institutions shorn up by governments.
While the banking system as a whole no longer looks threatened by mass failure, it may still not be in a position to finance a vigorous recovery.
Second, central bankers know that the challenges remain immense over when and how to unwind their extraordinary financial support programmes and to raise interest rates.
Third, they know that when the crisis is over, they will have to reinvent central banking in a way that takes account of the lessons of the crisis and reduces the likelihood of a repeat.
They will not be able to return to the status quo ante, in which they focused primarily on consumer price inflation. They will have to grapple with financial stability issues and develop the right mix of old and new tools to do so.