The ECB vs the FED

And the ECB? – you will need to explain why the ECB has taken a different route in dealing with the crisis.

The European Central Bank has been participating by pouring money into the financial market since the credit crisis along with the Federal Reserve. The ECB was the first bank to save the markets from crashing at the start of the credit crisis in August. The ECB made an injection worth 150 billion Euros liquidity. Such high liquidity injected into the system was done so to prevent higher inflation. Further more, the ECB after several meetings regarding the crisis, indicated that it was in position to injecting more money into the markets. The ECB did not follow the United States when changing the interest rates dramatically. ECB kept its interest rate at 4 %, staying in the euro zone. ECB did manage to stir short-term interest rates at a good level but kept the long term interest rates at a very high level. The Federal Reserve on the other hand immediately lowered the discount rate to 5.75% at the start of the crisis which was a 50 % drop. The ECB is focusing more on keeping the inflation adapted to the euro zone such as keeping the interest rate around 4 %. The Federal Reserve is under pressure since the inflation broke out and believes the ECB has taken a very different path. The United State is focusing less on the economy’s health whereas Europe rather maintains its position within the euro zone. The two institutions are clearly standing on different stance. ECB has two goals in mind and one to keep the price stable and the second to filter in as much liquidity in order not to increase inflation. The ECB’s attitude is said to be of “strong vigilance” regarding inflation. The Federal Reserve is focusing more on repairing the subprime damages and gaining back confidence from the investors. It is clear that the ECB and Federal Reserve were not on the same page since the crisis last August 2007. The ECB was predicted to raise the rates by the last quarter of the year and the FED to lower the interest rates by 50%. The ECB wants to keep injecting liquidity in the money markets in order to keep the businesses working and contributing to the economy with the funds given by the banks. The President of ECB, Jean Claude Trichet stated while in a conference in Frankfort “to leave interest rate unchanged…” Although, interest rate are to be risen in the future quarters but in the meanwhile will stay in the euro zone.

The ECB believes by keeping the prices stable and the interest rate within the euro zone and delivering such goals will create stability, job creation, and sustainable growth not only for Europe but for the rest of the world. The ECB has created 15.7 million jobs since the 1999 crisis till now. Such statistics are reassuring to the ECB.

Why is the ECB taking another direction? All central banks experience uncertainty especially during a time of crisis. The economy depends on them since banks are the main source and control of money. It is difficult to trace back to the real causes of the economic fluctuations and finding a solution. Changes within the money system can cause a greater problem but is needed to overcome a recession or disastrous economic fall which could affect the world. The Federal Reserve and the European Central Bank are taking different steps and the outcomes can be negative or positive, uncertainty still remains. The ECB and FED have developed in different structures with different policies. The ECB wants to follow the single market policy implied by the European Union. The main goals of Europe are to increase employment, strengthen the euro, and become an open trade market. The ECB is clearly on the EU’s side by not changing the rates and injecting liquidity in the market regularly to keep the businesses running and help Europe create more jobs. ECB’s focus is based on the EU’s economy, achieving a single economic entity. Such initiative to change towards some policy never experienced before by any other nations is difficult to base past macroeconomics facts from the past and therefore find the right solution to calm the credit crisis. The ECB is part of a very different system than of the United States. Europe has experienced very fast changes such as the introduction of the Euro which has had a great impact on the EU citizens and the economy. Therefore Europe has some expertise regarding rapid changes in the economy.

As said before, ECB’s main goal is price stability as a monetary policy. ECB is also independent from the other financial institution and therefore owns a high credibility influence and trust among the EU citizens. The ECB is even part of a treaty therefore all the other central banks in Europe will follow the decision made. The mission of ECB is to create a trust bond with the citizens and the banks. In order to achieve such trust, transparency must be shown. Unlike the US, The EU does not have a federal structure which was a problem when the single currency was introduced and voted by the EU citizens. ECB and central banks in Europe are different than in the states because every day they gather large amounts of information and statistics. Such act helps the central banks in the EU stay transparent and for the detection of internal problems. The Federal Reserve keeps a lot of its information to itself and the federal government rather than sharing it with the public.

The Federal Reserve monetary policy concept is choosing between job creation and economic growth. The ECB believes the two concepts work together. The FED does not truly believe in price stability increasing economic growth and job creation. The FED is more focused on the inflation and filling in the gaps where subprime loans were defaulted. The Fed is also changing rates to calm the credit crisis. ECB believe price stability will help them achieve their goal of transparency so the public can be involved and trust the system. The FED relies on long term solutions to prevent recession from happening and discount rate manipulation as well as long term interest rates. The FED and ECB are similar in many ways but so far the ECB has been more transparent regarding its goals. The ECB along with the Federal Reserve have been the main players in saving the money markets from crashing till they decided to divert due to different economical interests. Central banks need to remain flexible when responding to crisis and set different ways of dealing with the problem for future crisis.

Giverny Lowe

The Federal Reserve and US government vs. Credit Crunch

What did the US government and the Federal Reserve decide to do? – You will need to describe the steps the US government and the Federal Reserve have taken to try to mitigate the crisis.

The Federal Reserve and the US government have initiated steps to cut down the crisis and build some liquidity in the severely damaged areas of the financial markets. The estimated damages of the credit crunch regarding the US could exceed over $1.5 trillion. The Federal Reserve is cutting rates in half of their original percentages and recently up to 3 quarters. Such action has pressured the main central banks such s the Bank of England, but it was necessary to help the credit crisis cool down. The Federal Reserve has also been given around $30 billion to the banks monthly in order for them to recuperate.

The Federal Reserve has though taken bigger steps recently on March 11, 2008 where it decided to increase the amount of money given to banks for the month of March. The amount will include $100 billion. This is done in order for banks to keep circulating money and lend to their customers. This action plan is due for 6 months and the Federal Reserve is entitled to donate more if the crisis does not slow down.

It is also central banks along with the Federal Reserve to provide the money markets with bullions of dollars. The European Central Bank and the Central Banks from Canada, Switzerland, along with the UK will partake in the action. Today, $200 billion is the amount of money that is going to be circulating and given to the money markets in order to boost the world economy. Banks are in some tension between each other because they hold enough money to lend but since the credit crunch erupted they are less tempted to make transactions with each other and believe that each bank has insufficient assets.

Many countries are under the credit crunch and are beginning to show negative signs that will not ameliorate soon such as inflation in Egypt, most EU countries and even in the Balkan region. The Credit Crunch has started in the US and has affected the world economy and many countries and economists believe that the US will enter recession. The US government and the Federal Reserve believe in their action plan. It is important to understand that there is a great loss of confidence within the financial system. Banks and the financial market are built among our confidence. Banks act as a trust system. In the short run, banks can keep injecting money into the financial markets to help the liquidity downturn. But in the long run, the situation may become shaky. Not all customers will be paid back and the people will help pay up for the debts through taxes. The US government has raised taxes as well as a solution to ease the credit crunch.

The Federal Reserve is taking some actions that can end up risky when using assets that could hold mortgage securities which were the initial spark behind the crisis. The US government and the Federal Reserve have agreed with the European Central Bank to lend funds in dollars. Such step is called a currency ‘swap’ agreement meaning that banks bid for around $30 billion in funds while the European Central Bank assigned a portion of the $15 billion agreed lent to the US Federal Reserve.

The Federal Reserve is not only helping banks out but investment houses such as the Wall Street one. This will help the financial markets access funds with more confidence. The Federal Reserve is ready to risk more and is most likely to impose a bigger cut on interest rates which will affect businesses and people but it is needed in order to keep the business world flowing. The past week, the Federal Reserve emerged out with a program that gives emergency loans to the top 20 dealers in the US. The dealers are investment banks and are connected to the Federal Reserve since they possess most of the Treasury securities.

Since the beginning of the credit crunch, the Federal Reserve has been cutting interest rates and discount rates, along with injecting assets in the money market and is now directly borrowing from banks in order to stir away from a recession in the United States. The credit crisis will not end so fast and it will take a world effort to resolve it.

-Giverny Lowe