(Adds more remarks from Orphanides.)
WASHINGTON -(Dow Jones)- Central banks in Europe and the U.S. have taken decisive action in response to the global financial collapse, and appear to have succeeded in averting a severe depression and deflation, Cyprus Central Bank Governor Athanasios Orphanides said Saturday.
"Although uncertainty remains, the world economy today seems to be on its way to recovery," Orphanides said in remarks prepared for delivery to an international monetary policy conference at the U.S. Federal Reserve Board.
Orphanides praised actions by central banks that have cut short-term interest rates to near zero, saying central bankers took "appropriate and effective policy easing on both sides of the Atlantic."
While Orphanides acknowledged that there are challenges posed for monetary policy makers when short-term rates are near zero, he said the fact that real interest rates are so low partly reflects the success of central bankers in battling inflation to low levels.
Orphanides also cautioned against viewing near-zero rates as inherently inflationary, saying that at even rock-bottom levels, rates may need to be lower to combat deflation.
"Near-zero policy rates that may be considerably expansionary in an economy with high inflation could be contractionary when inflation is too close to zero, or worse, deflation has set in," he said. "In a deflationary economy, even zero rates can be contractionary."
Nor should central bankers worry that if they cut rates to near-zero levels, they will have no tools left in their arsenal, Orphanides added. He said the notion that central banks need to hold back on cutting rates to very low levels in order to have some ammunition left can result in rate cuts that are less aggressive than what is needed to stimulate a slumping economy. He said holding back when aggressive rate cutting is needed could be counterproductive, resulting in slumping demand and even deflation.
Even when short-term rates can't be cut further, central bankers have other tools available to stimulate demand, including purchases of investments that inject money into the economy, Orphanides said.
"Monetary policy decisions that change the size or composition of the central bank's balance sheet can potentially influence various asset prices and the yield curve of government and private paper, even when the overnight interest rate does not move," he noted.
Orphanides hailed academic research begun at the Fed in the early 1990s, which he said helped U.S. monetary policy makers when the global financial crisis hit in 2008. He said the decades-old research wasn't just academic, as the Fed was able to draw on older studies of unconventional stimulus that had examined legal issues of asset purchases, the possible use of derivative instruments and the historical experience in the U.S. in the 1930s and in Japan in the 1990s.
Close cooperation between central bank researchers in the U.S. and Europe confirmed the desirability of responding forcefully to turbulent economic times, cutting rates to zero levels and making unconventional asset purchases as needed, Orphanides added. He also endorsed the need for central bankers to communicate clearly and openly at such times, explaining that aggressive actions should not be viewed as undercutting a commitment to price stability.
Copyright 2009 Dow Jones Newswires
UPDATE:Bernanke Sees Short-Term Rates Rising On Stronger EconomyPrice drop means low interest rates
