No end in sight to recession, warns Fed

Financial administration officials in the United States are convinced the current recession will be the longest and deepest ever since World War II.

Philadelphia Federal Reserve Bank president Charles Plosser said yesterday that he expects economic growth for 2009 to be well below two per cent, after having already shrunk in 2008.

At the same time, Fed chairman Ben Bernanke warned that fiscal stimulus alone would not be sufficient to overcome the global economic crisis.

Speaking at a conference in Newark, Plosser said, "Our aggressive lending, while intended to help the economy and financial crisis recover, poses its own set of challenges," The Federal Reserve must articulate a clear exit strategy from its emergency lending programmes, he added.

At the same time, IMF chief Dominique Strauss-Kahn said the global outlook was worsening, and warned that the International Monetary Fund was likely to slash its already gloomy growth forecasts.

To support the credit markets, the Fed has more than doubled its balance sheet to over $2 trillion through measures like buying assets. Plosser told reporters after his speech that he would prefer the Fed's balance sheet to be "a little more pristine". Asked whether the Fed would buy Treasuries, Plosser said it is discussing buying longer-dated bonds, but has not made a decision yet.

In addition to unconventional policy tools, the Fed has brought down its benchmark overnight funds rate target to between zero and 0.25 per cent. "Without the target funds rate as a nominal anchor, it will be important for us to develop relevant quantitative measures to assess the appropriate size and composition of the Fed's balance sheet," Plosser said.

"Credit policy alone is not sufficient to ensure sound monetary policy," he warned, adding that while some of the emergency lending facilities will unwind naturally, other assets like the mortgage and asset-backed securities could stay on the Fed's balance sheet for years.

Meanwhile US Fed chairman Ben Bernanke said in a speech in London that while the expected the US stimulus package could provide a "significant boost" to the economy, the government may need to inject more capital into banks and consider buying financial institutions' 'toxic' assets.

"Fiscal actions are unlikely to promote a lasting recovery unless they are accompanied by strong measures to further stabilize and strengthen the financial system," he said.
Toxic assets

Outgoing Treasury Secretary Henry Paulson and Bernanke had pressed Congress in September to approve a $700 billion bailout fund so the government could buy up the bad debts. But Paulson turned his focus to purchasing equity in banks, which he has argued was a quicker way to shore up the system.

With half the money already spent, Obama faces his first big test in persuading sceptics in Congress to release the remaining $350 billion so it is in place when he takes office next week.

Citigroup, till recently the world's biggest financial services group, has adopted what observers call the 'good bank, bad bank' approach. It has agreed to merge its Smith Barney brokerage with Morgan Stanley's wealth management business, and may isolate toxic debts in a 'bad bank'.