Transcripts of the monetary policymaking body of the Federal Reserve from 2002–2008.

In response to intensified global financial stresses, the central banks of four major emerging market economies—Mexico, Brazil, Korea, and Singapore—have recently expressed interest in temporary liquidity swap lines with the Federal Reserve. For the reasons outlined in our background memo, which was circulated on Friday, the staff recommends that the Committee approve these requests. We propose that the lines be sized at $30 billion for each of these four countries, similar to our existing lines with Canada, Sweden, and Australia. We envision that these lines would expire on April 30, 2009, as is the case with our other swap lines.

We also recommend that these lines have several safeguards relative to our lines with central banks in the advanced economies. Notably, even following initial FOMC approval, the proposed lines could not be drawn on without further authorization, and individual drawings would be limited to $5 billion. We recommend that the FOMC delegate to its Foreign Currency Subcommittee the authority to approve these drawings. The subcommittee would ensure that the dollars drawn would be used in a manner consistent with the purposes of the swap agreement. The central banks in these countries would also agree to publicly announce the fact that they had drawn on their lines and the mechanisms that they had used to allocate the dollar liquidity. These safeguards are designed to provide protections for Federal Reserve resources and to ensure that the swap lines are used in a manner consistent with our envisioned objectives. These safeguards, however, are not intended to be so onerous as to discourage the use of the lines if the situation warrants.

We see the case for these swap lines as resting on three important observations. First, each of these economies has significant economic and financial mass. Mexico, Brazil, and Korea are all large economies with GDP of around $1 trillion, and Singapore is a major financial center. Given the structural interconnectedness of the global economy and the financial fragilities that now prevail, a further intensification of stresses in one or more of these countries could trigger unwelcome spillovers for both the U.S. economy and the international economy more generally. Our interdependencies with Mexico are particularly pronounced. Second, these economies have generally pursued prudent policies in recent years, resulting in low inflation and roughly balanced current account and fiscal positions or, in the case of Singapore, sizable surpluses. Accordingly, the stresses that these countries are feeling seem largely to reflect financial contagion effects from the advanced economies, including sharp reductions in risk appetite, rapid deleveraging by global investors, and a drying up of liquidity in dollar funding markets. Third, there is good reason to believe that swap lines with the Federal Reserve would be helpful in defusing the economic and financial pressures that they now face. These lines would promote financial stability by helping to ensure that financial institutions and corporations in these countries have access to dollar liquidity. Dollar funding pressures in Brazil and Korea appear to have intensified significantly. Such pressures remain less acute in Mexico and Singapore, but the authorities there view these lines as valuable protection should such pressures intensify, particularly over year-end. In addition, the authorities in these countries have expressed the view that these lines could provide a significant boost to confidence, although such outcomes are admittedly hard to predict.

I turn now to two questions that have been the focus of energetic deliberations among the staff as we have formulated these proposals. First, is there some better approach that we could recommend? Second, what are the risks associated with initiating swap facilities with these emerging market economies, or EMEs?

As for the first question, we could ask these countries to rely on their sizable stocks of foreign exchange reserves. Across many contingencies, we believe that these countries do have sufficient resources to address financial pressures on their own. Consistent with this observation, they don’t have any immediate plans to draw on their swap lines. In this sense, the lines serve as a backstop. However, in the event of intensified stresses, we believe that it would be desirable for these countries to able to meet the dollar funding needs of their institutions by drawing on the swaps rather than by going into the Treasury or agency markets to liquefy their foreign exchange reserves. Alternatively, we could ask these countries to go to the IMF. Tomorrow, the Fund is likely to approve a large, rapidly disbursing facility that might be appropriate. That said, we see the IMF’s efforts in this area as broadly complementary to those of the Federal Reserve. Meeting the potential liquidity needs of these large countries would strain the available resources of the Fund. Conversely, the Fund is much better placed than we are to judge the liquidity needs of smaller, less systemically important countries. As an additional consideration, these top-tier EMEs that we are recommending for swap lines are very reluctant to return to the IMF. Given the strength of their policies, they no longer view themselves as clients of the Fund and would prefer to go it alone rather than seek IMF financial support.

We note that there are indeed risks associated with our recommendation. One obvious concern is that the swaps might not be repaid. However, given the large reserve holdings of these countries, their prudent policies, the weight they place on good relations with us, and the safeguards built into the swap agreements, we judge the risk to Federal Reserve resources to be very low. More notable is the risk that approving these lines might cause us to be flooded with requests from many additional EMEs. Nevertheless, in proposing lines with these four countries, we feel that we have set the bar quite high. Their importance to the global economy and the quality of their policies set a standard that few, if any, other EMEs can match. In addition, the potential IMF liquidity swap facility might be helpful to us in limiting the risk of a slippery slope, as additional countries that request lines with us could be asked to go to the IMF. Similarly, European EMEs seeking swap lines could be encouraged to approach the ECB.

In assessing these issues, the staff has conferred with senior officials at the U.S. Treasury and the State Department. In both instances, these agencies emphasized the global economic significance of Brazil, Mexico, Korea, and Singapore. However, they also cautioned that expanding the swap lines beyond this group could leave us increasingly vulnerable to a “pile on” effect, which might manifest itself either in a large number of additional swap line requests or in political pressure. Given these considerations, the staff would benefit from some signal from the FOMC regarding its willingness to consider swap lines with other emerging market economies. We see two broad options in this regard. First, the FOMC could indicate that it is not inclined to establish swap lines with other EMEs. Inquiries from additional countries could be forwarded to the IMF. Alternatively, the FOMC could emphasize that the bar for any additional EME facilities is high and that swap lines would be extended only if the case is seen as being comparable to that of the four countries that are being voted on today. Under this second approach, the FOMC might consider granting the Foreign Currency Subcommittee the authority to establish swap lines with the central banks of other large and systemically important EMEs. Bill Bassett will now continue our presentation.

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