BSP can’t shield RP from US fallout – Nobel Prize winner

Philippine Star, February 8, 2008

Nobel prize-winning economist Finne Kydland said there is very little that the Bangko Sentral ng Pilipinas (BSP) or other central banks could do to prevent the fallout from the US subprime crisis.

Kydland, who won the Nobel Prize for Economics in 2004, is visiting the country for a series of talks on economic development.

Kydland was recognized together with economist Edward Prescott “for their contribution to Dynamic Macroeconomics: The Time Consistency of Economic Policy and the driving forces behind business cycles.”

In a reception hosted by the BSP, Kydland said central banks in general could not do much to the real economy outside of ensuring that inflationary expectations are well-anchored.

According to Kydland, the US subprime crisis had more ways to go, however, and economic planners should expect this to lead to a reduction in investments, some reduction in consumption and possibly even to recession.

“If you ask me what the central bank can do about the subprime crisis? Well, not much,” he said. “If the crisis is to last for a while, then the economy will be much less productive for a while.”

For the BSP or any other central banks to do much, however, Kydland said it would have to be “something that would affect future earnings.” To the extent that central banks could alleviate the resulting cautiousness among banks, he said regulators could lessen the negative perception.

“Too much caution can be bad and central banks can do something to lessen this cautiousness but they cannot do much to affect immediate earnings potential,” he said. “What central banks do is to provide the environment.”

Kydland expressed alarm over the moves of the US Federal Reserve Board after it cut US rates by 75 points less than a week before its scheduled meeting where it also cut its rates by another 50 points.

According to Kydland, the US Fed’s decision came right after a major plunge in US share prices as the market anticipated the US economy to drop deep enough to head into a recession.

“I’m a little disturbed by stocks falling then the US Fed cutting its rates,” he said. “That sounds very bad. What business does the central bank have keeping up the stock market?”

According to Kydland, it was inevitable for the US Fed to cut its policy rates but the cut should have waited for the right time which he said was the usual time that the Fed was scheduled to meet.

The BSP, on the other hand, remained wary over the fallout not just from the US subprime crisis but from the very decisions being made by the US Fed especially since it was releasing huge amounts of liquidity into the system.

BSP Governor Amando M. Tetangco Jr. said the Philippines would benefit from the policy moves of the US Fed if it succeeds at averting a recession in the US.

“Averting a recession is the Fed’s short run concern,” Tetangco said. “So, to the extent that they are successful in avoiding a major slowdown, this is positive not only for the Philippines, but also for other countries that trade with the US.”