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World Bank chief warns of spreading crisis


By Lesley Wroughton

WASHINGTON | Thu Sep 22, 2011 6:40pm EDT

WASHINGTON (Reuters) - Protectionism and populist policies in the developing world could rise as countries face increasing head winds from a growing European sovereign debt crisis and a weakening economic recovery in the United States, World Bank President Robert Zoellick said on Thursday.

Zoellick warned another crisis was building at a time when the budgets of many developing economies had not fully recovered from the 2008 financial storm, adding to their fiscal strains.

He told Reuters in an interview more than half of developing countries' budgets have deteriorated by 2 percent of gross domestic product since 2007, and more than 40 percent of developing nations now have government deficits in excess of 4 percent of GDP.

"If the situation deteriorates further, then developing countries' growth could turn down, their asset prices could drop and then their non-performing loans could increase," Zoellick said.

"With these pressures and prospects we have to anticipate possible protectionist pressures, beggar-thy-neighbor policies and a risk of a retreat to Populism," he added.

While he still believed advanced economies could avoid a double-dip recession, Zoellick said his concerns were growing unless they acted forcefully to tackle their problems.

"A crisis made in the developed world could become a crisis for developing countries," he said. "Europe, Japan and the United States must act to address their big economic problems before they become bigger problems for the rest of the world.

"Not to do so would be irresponsible," he added.

Developing economies, he said, had grown more resilient over the past decade and were in a better position to withstand another crisis but they were still concerned about the spillover effects from troubled advanced economies.

Some of the largest impacts to poorer countries would be felt through a decline in global demand, which would affect trade and commodity prices.

Zoellick said $6.1 trillion was wiped out globally in stock market declines over the past couple of months, which is equivalent to 10 percent of global GDP.

A meeting of finance leaders from emerging market economies -- China, India, Russia, South Africa and Brazil -- in Washington on Thursday called for 'decisive action' by advanced countries to tackle the deterioration in their economies.

"The best role for the BRICS countries is the same as the best role for any country, which is to focus on what they need to do at home to get through the current financial dangers and to move on to long-term growth," he said.

Zoellick said he was paying close attention to consumer and business confidence in emerging economies.

(Editing by Neil Stempleman)

Fed Focus: Bernanke's twist may do little for jobs
By Ann Saphir

Thu Sep 22, 2011 1:16pm EDT

(Reuters) - The Federal Reserve's latest effort to push down long-term U.S. borrowing costs may not do much for the central bank's main worry -- persistently high unemployment that could leave lasting scars on the economy.

Economists say they are increasingly anxious that the 9.1 percent jobless rate in the United States could become entrenched. Those out of work for a long period face a vicious cycle as their skills atrophy and their job market connections wane, sidelining them and chipping away at the U.S. economy's capacity to produce.

"The Fed is doing all that it can to stimulate the demand side of the economy in an environment where 'all that it can do' is 'not very much,'" said Mark Setterfield, an economics professor at Trinity College in Hartford, Connecticut.

He is the author of a book on persistently high unemployment, sometimes known as hysteresis.

The term is borrowed from physics, where it is used to describe a temporary effect that becomes permanent, even when whatever triggered the initial effect is removed. In the labor market, it is used to describe a self-feeding cycle where even after demand returns, unemployment remains high.

"We went to 9 percent unemployment quite quickly, and we have basically been stuck there," Setterfield said. "There has to be the concern that that type of hysteresis effect is going to add insult to injury."

On Wednesday, the Fed moved to offset what it called "significant downside risks" to the already weak U.S. economy with a new $400 billion program to weight its $2.85 trillion balance sheet more heavily toward longer-term securities.

But Wall Street sees only a 15 percent chance that the Fed's latest plan will give the U.S. economy a meaningful boost, according to a Reuters poll conducted after the Fed's announcement.

DO THE TWIST

The idea behind the move, nicknamed "Operation Twist" after a similar policy in the 1960s, is to push down long-term borrowing costs to encourage mortgage refinancing and consumer and business borrowing.

The Fed also sought to give the housing market a direct boost by promising to keep its mortgage-backed securities portfolio at its current size.

But with unemployment so high, households worried about their future prospects may be more focused on paying down debt than taking out new loans.

Without new spending, economists like Setterfield argue, the jobless rate will level off at a high level -- no matter how low the Fed pushes interest rates.

The Fed's grim outlook for the U.S. economy and data showing China's contracting factory sector drove U.S. stocks down 3 percent on Thursday on fears of a global recession.

"Investors seem to be waking up to the fact that monetary policy is pushing on a string," said Capital Economics analyst John Higgins. "The stock market and commodities are likely to continue to struggle, given the gloomy outlook for the economy that the Fed openly acknowledged on Wednesday."

Thomas Lam, OSK-DMG chief economist, put the economic impact of the Fed's "twist" operation at less than half a percentage point of added growth -- slightly below a Goldman Sachs estimate.

Even the Fed does not know exactly what to expect, saying it is "difficult to estimate precisely" how much of an economic boost the program will deliver.

But such concerns probably will not prevent the Fed from doing even more if need be, said Eric Stein, a portfolio manager at Eaton Vance in Boston.

"I think (Fed Chairman Ben) Bernanke and (New York Fed President William) Dudley and (Chicago Fed President Charles) Evans and (Fed Vice Chair Janet) Yellen are committed to doing whatever it takes to get the economy going," he said.

"I think they'll continue pushing for things unless the world gets materially better," Stein said.

Bernanke has repeatedly cited sustained high unemployment as a chief concern. In its statement following Wednesday's policy-setting meeting, the Fed pointed to an "elevated" jobless rate that will decline only gradually.

Laurence Ball, an economics professor at Johns Hopkins University, said, "Chairman Bernanke may be ... over-optimistic, in the sense that he is thinking about unemployment coming down slowly and painfully."

The concern is not limited to academics.

San Francisco Federal Reserve Bank President John Williams, who rotates into a voting spot on the policy-setting Federal Open Market Committee next year, has raised the specter of permanently high U.S. unemployment outside a recession, something unseen since the end of World War II.

"One of the concerns is, if unemployment stays very high for very long, people are out of work for several years, that's going to have a much more persistent effect, despite the history," Williams told reporters after a September speech, hinting the Fed had more room to ease policy.

While the Fed wants to cut the unemployment rate, many economists say it has little chance of success as long as politicians fail to deliver fiscal stimulus or job programs.

That's the argument often made by Dallas Fed President Richard Fisher, one of three FOMC members who dissented on Wednesday against its latest policy experiment -- or 'twist.'

Still, those concerns have not stopped the Fed's majority so far, and the threat of entrenched unemployment is likely to push them to do even more unless the economy picks up soon.

As JPMorgan's chief economist Michael Feroli observed, "Monetary policy's toothpaste tube is rolled up to the very end, and Bernanke is squeezing it with both hands, but there's just not much left in there."

(Reporting by Ann Saphir; Editing by Jan Paschal)