Federal Reserve Bank of Philadelphia President Charles Plosser spoke Saturday with The Wall Street Journal’s Brian Blackstone in Eltville, Germany. Mr. Plosser discussed risks to the U.S. from the Greek crisis, the Fed’s tools to contain any fallout and the central bank’s evolving communications strategy.
On whether Europe could have a significant effect on the U.S. economy:
Plosser: Europe is clearly near recession. That impacts the U.S. in part through trade. That has negative impacts but Europe is not our largest trading partner at the end of the day. The thing that people really worry about is you have some financial implosion in Europe and markets freeze up and you have some serious financial disruptions.
There are several ways this could go. At one level the U.S. has been trying to insulate itself from that risk. The Fed and regulators have tried to stress to money market funds, for example, to reduce their exposure to European financial institutions. So on a pure exposure basis I would say U.S. financial institutions are taking the steps they need to ensure that if there’s really financial distress in Europe it doesn’t necessarily lead to distress for them as an institution.
People have made the analogy that an implosion in Europe would be a Lehman Brothers-type event. It might be a Lehman Brothers-kind of event for Europe. And if the market is sort of indiscriminate in whom they withdraw funding to, you could have indiscriminate funding restrictions on U.S. institutions just because everybody’s scared.
There’s another scenario that is exactly the opposite. There might be–and you already see some of this–a flight to safety. So rather than the markets freezing access to short-term funding for U.S. institutions, you could have a flood of liquidity that gets withdrawn from European institutions, if that’s who they’re worried about, and floods into the United States. That’s exactly the opposite problem.
On which scenario is more likely:
Plosser: I don’t have the answer to that. The first point I made about U.S. institutions reducing their exposure to Europe, that tendency tends to move me into the camp where U.S. institutions are not as at risk and therefore it might be more the flood of liquidity than the drying up of liquidity. That’s one of the uncertainties that we just don’t know the answer to.
On what the Fed can do to limit any fallout from Europe:
Plosser: It can only react. The swap lines we have with the European Central Bank are one way to support U.S. dollar funding in Europe. I don’t think a flood of liquidity is a huge problem. That would be manageable. The bigger problem is if it dries up for everybody. The Fed still has the tools it used during the crisis. We have the discount window and we have the ability to lend to financial institutions at a penalty rate against good collateral. And we have on the shelf some of the tools we used during the crisis: the Term Auction Facility and longer-term lending through the discount window to help mitigate that. So I think we have the tools at our disposal if they become necessary.
On whether the Fed is captive to events in Europe:
Plosser: We’re not captive. It’s just harder to read the data. I think that Europe is just throwing a lot of noise into the system right now. The markets seem to be more sensitive about what’s going on in Europe than what’s going on in the U.S. It makes it tougher to extract signals on our own economy. If you’re trying to use U.S. interest rates as a signal about the U.S. economy, in part it’s getting swamped from these liquidity flows from Europe.
On how Europe affects his economic forecasts:
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5/29/2012
Q&A: Philadelphia Fed President Charles Plosser
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