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Tue. November 13, 2018
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IA-Forum Interview: Dr. Viral V. Acharya
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International Affairs Forum: What do you view as the major differences between monetary policies of the ECB and the Fed since the start of the global economic crisis? Dr. Viral V. Acharya: In the first phase of the crisis, the Fed was a lot more aggressive in lowering interest rates and adopting an expansionary monetary policy compared to the ECB, and even the Bank of England. I think one of the reasons was that the commodity price inflation of 2008 was so substantial that perhaps both the ECB and the Bank of England were caught off-guard and leaned on the side of not adopting an expansionary policy right away in order to tackle inflation. However, since we had the problems of August and September 2008, and especially since bankruptcy of Lehman Brothers, central banks across the world over started adopting highly expansionary monetary policies. There have, however, been a few significant differences between the exact kind of policy the Fed had adopted and the kind of policy the ECB had adopted. This has been especially true since 2009. In the first year after Lehman Brothers, the Federal Reserve grew its balance sheet quite substantially (Quantitative Easing I or QEI). This was essentially between the agency debt, which is Fannie Mae and Freddie Mac debt (implicitly backed by the United States government), and Fannie and Freddie-guaranteed mortgage-backed securities. The Fed built a portfolio of over a trillion dollars this way, which reduced the supply of these securities in the market. But the second round of easing that the Federal Reserve engaged in since August 2010 (QEII) was primarily through purchase of the relatively safe Treasury securities. Now when you compare that to what the European Central Bank has done since Fall of 2008, from all accounts it seems that the ECB was by and large fairly aggressive, providing liquidity to the banking system against relatively illiquid mortgage-backed securities. But more importantly, its problem got especially complicated a year later in 2009 when sovereign creditors faced a very significant issue, starting with the problems in Greece then eventually in Spain, Portugal, and quite severely in Ireland too. It might look as though the ECB's policies were to buy back some of the government debt on the market, just as the Federal Reserve has, but the kind of government debt that we're talking about is of a substantially lower quality in the case of the ECB than the Federal Reserve. To the extent that some of the European sovereign debtors are reasonably credit risky right now, I would say the ECB’s operations represented essentially a quasi-fiscal action of the type that perhaps Federal Reserve's operations with Bear Stearns or AIG or Citigroup were, where it was directly taking on significant credit risk on some of the assets it backed in the process. The circumstances have been such that the lack of a direct and decisive fiscal response from the Euro zone, that is, the stronger Euro zone countries and the European Union as a whole, has meant that unfortunately ECB has had to start playing the quasi fiscal role. And now it risks taking some haircuts on its exposure of close to 100 bln Euros of sovereign debt, that would require recapitalization. IA-Forum: Do you think either has done a better job at positioning themselves toward moving forward? Dr. Acharya: I would say that, at least in terms of outcomes, the United States is certainly in a better situation than Europe is right now. One striking difference between the United States and the Euro zone has been that the recapitalization of the financial sector in the United States was quite decisive and quite transparent to the markets. Once stress tests were conducted and recapitalization, largely a private recapitalization, was undertaken in the summer of 2009, the health of the U.S. financial sector became far less of a worry. The main worry in the United States right now is whether aggregate demand in the household spending picks up or not. But I think the United States is perhaps is in as good a condition as it has been in the last several years, even though the recovery has been bumpy. In Europe however, it is unclear if banks really took write-downs up to the extent that they needed to take. This meant that they were not recapitalized adequately in time. And because this did not happen, when the eventual sovereign creditors problems surfaced in 2009 and 2010, any prospect of debt restructuring of Greece, Portugal, Spain and Ireland, got deeply intertwined with the question of, who's holding the bonds of these countries and their banks? Is it French and German banks, or other banks of leading countries in Europe? And whether they need their own restructuring to contain knock-on contagion effects onto these banks in other countries. Effectively therefore, the lack of adequate capitalization of the banking sector in the Euro zone or at least lack of any conviction from the regulators that the capitalization is good, the market has experienced what I would call a sort of a generalized uncertainty or the threat of a panic. The main problem this has created is that we can't really make progress with any restructuring of sovereign debt because if we do it we don't know what's going to happen next, and that is because we don't know which banks might drop to lower quality as a result and how the losses might actually spread from one country to the next. This has happened partly because the European stress tests were not just done by one entity, as there's home country supervision and there's home country regulation, in the Europe. Some of the efforts underway in the Euro zone right now are to harmonize these processes a lot more. But the bottom line is that in terms of ensuring that the recapitalization of the financial sector was good enough to deal with the next shock that hits the markets after the fall of 2008, the U.S. authorities and the regulators have done a much better job than in Europe. To the extent that the Fed and ECB are involved in these exercises I would give higher marks to the Fed than to the ECB. Dr. Viral V. Acharya is Professor of Finance at New York University Stern School of Business (NYU-Stern), Research Associate of the National Bureau of Economic Research (NBER) in Corporate Finance, Research Affiliate of the Center for Economic Policy Research (CEPR) in Financial Economics, Research Associate of the European Corporate Governance Institute (ECGI), and an Academic Advisor to the Federal Reserve Banks of Cleveland, New York and Philadelphia, and the Board of Governors.

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