Europe appears to be making enough progress in dealing with its debt crisis that the U.S. central bank probably will not need to take any more action to shield the U.S. economy from the possibility of harmful spillover on exports or jobs, a top Federal Reserve official told a congressional panel on Tuesday.
William Dudley, president of the New York Federal Reserve Bank, said European liquidity concerns were easing, and funding costs for governments throughout Europe had declined. He said U.S. authorities were watching closely and defended a decision to provide dollar swap lines to Europe as having been in the best interests of the United States.
"I am hopeful that Europe can effectively address its current fiscal challenges," Dudley told the U.S. House of Representatives Financial Services subcommittee. "At this time, although I do not anticipate further efforts by the Federal Reserve to address the potential spillover effects of Europe on the United States, we will continue to monitor the situation closely."
His comments were similar to congressional testimony a week earlier by Fed Chairman Ben Bernanke, who said financial stresses in Europe had eased in recent months and that U.S. bank exposure to potential losses from credit default swaps they sold to protect against a possible European sovereign debt default were manageable.
Dudley described the U.S. economy as growing moderately and added a caution that some strains persist in financial markets, and they "continue to pose significant downside risks" to the outlook.
BENEFITS OF DOLLAR SWAPS
He noted that dollar swaps the U.S. central bank had set up for European financial institutions, together with actions by the European Central Bank to increase liquidity, had helped add stability to Europe's banking system.
"In conjunction with the ECB's long-term refinancing operations, the swaps have helped European banks avoid the significant liquidity pressures we feared a few months ago, and have reduced the risk that they would need to sell off their U.S. dollar assets abruptly," he said.
Dudley didn't entirely rule out more Fed actions if necessary to counter Europe's downturn, but stressed that any such action would be for the United States' benefit.
"I don't think the Federal Reserve has made any decisions about what future interventions we would or we would not do, except we will do interventions that are consistent with our dual mandate as set by Congress to achieve maximum employment and price stability ...," he said. "That's why we are doing these programs, not for Europe, but for ourselves."
European officials continue to discuss how to build up a credible funding firewall to further reassure markets that a debt crisis that has severely affected some countries like Greece will not be permitted to spread to central Europe.
Dudley stressed that if they do not decisively address the crisis, there could still be adverse consequences for the United States.
"If economic conditions in Europe were to weaken significantly, demand for U.S. exports would decrease," he said. "This would hurt domestic growth and have a negative impact on U.S. jobs."
In addition, that could put pressure on the U.S. banking system, Dudley said.
In response to questions, Dudley said the United States had never lost money when it provided dollar swap lines to foreign officials, a practice normally undertaken to ease stresses in financial markets, but one that also makes it easier for foreigners to keep buying U.S. exports.
"During the depths of the financial crisis in 2008-09, a far worse economic environment than which we are in today (with) far greater amounts of swaps outstanding, we were fully repaid," he said. "We didn't lose a penny. In fact, the total profit to U.S. taxpayers from the swaps was about $4 billion."
Dudley suggested there might even be some residual benefit from offering swap lines because they enhance the dollar's status as the world's reserve currency.
"At the margin, it probably enhances the dollar as a reserve currency," he said. "The fact that the Federal Reserve is willing to engage in dollar swaps probably makes more people more comfortable to use the dollar to finance international transactions around the world."
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