Chairman Campbell, Ranking member Clay, and members of the committee I am pleased to offer testimony on practices of central banks since the great financial crisis of 2008. While the last 5 years has been a very challenging period for all central banks, a review of practices and outcomes will suggest that the Federal Reserve and the United States have performed very well relative to other countries based on yard sticks measuring economic performance.
I will start with an overview of central bank practices since 2008, then review the practices in some detail, present a summary of economic and financial performance since 2008, and finally, discuss the policy dilemma facing some central banks.
Among major central banks, the Federal Reserve has been the primary innovator since the 2008 financial crisis presented governments and central banks with serious challenges. Given the global reach of the crisis and the threats of deflation, persistent unemployment and low growth, and potential insolvency of banks and insurance companies, other central banks have, to varying degrees, followed the Fed’s lead.
The 2010-11 European banking crises arose after revelations that Greece, along with several other countries in the European Union, had been severely misrepresenting their fiscal problems.
The challenges presented to the European Central Bank (ECB) were severe. Unlike the United States, the ECB is responsible for conducting monetary policy for the entire European Union, composed of 28 disparate economies, each with its own separate and independent finance ministry. The right monetary policy for Germany is not the right policy for Greece, Spain, or Italy, to mention only the most prominent examples of countries approaching outright deflation because of a toxic, for them, combination of ECB’s stringent monetary policy and fiscal austerity. Japan and Switzerland have also faced challenges springing from deflation pressures that have required them to employ aggressive monetary measures in order to avoid persistent currency appreciation that would at once symbolize and exacerbate the problems they face. In effect, both have taken measures to avoid importing deflation pressure, a more useful description of the impact of currency appreciation.
The Bank of Japan (BOJ) with a longer standing (15 year) deflation problem has been more innovative than the Swiss National Bank (SNB), relying more, especially since early this year, on a combination of aggressive quantitative easing coupled with forward guidance of the sort engineered by the Fed since 2010.
Both the SNB and the People’s Bank of China (PBOC) have instead relied heavily on direct currency intervention, large purchases of foreign exchange (especially dollars in the case of China and Euros in the case of the SNB) to avoid the deflationary impact of substantial home currency appreciation. China’s intervention has resulted in its widely-noticed surge in foreign exchange reserves, at $3 trillion and counting, a substantial portion of which has been employed to purchase US treasury securities. That outcome has benefited both China and the US. China’s need to store trillions of dollars worth of foreign exchange reserves, to prevent appreciation of its currency, has been accommodated by the US, which in turn has benefited from substantially lower borrowing costs. The surge in US borrowing from China since 2008 has accommodated trillion dollar plus budget deficits, incurred in part to finance programs of fiscal stimulus.
The balance of my testimony, in response to Chairman Campbell’s direction, summarizes the post-crisis policy tools of major foreign central banks, benchmarked against the Fed’s post-crisis policy innovations and track record. Overall, the Fed’s post-crisis performance compares favorably with other central banks in a very difficult economic and financial environment, where no nation has regained pre-crisis financial leve