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Fed's Warsh says U.S. economy in state of "panic"

WASHINGTON (Reuters) - The U.S. economy is in a state of a panic that predated the official recession and may have significant long-run implications, a Federal Reserve official said on Monday.

In remarks to the Council of Institutional Investors, Fed Governor Kevin Warsh said that while the pace of economic decline was likely to abate, “I am decidedly uncomfortable forecasting a sharp and determined resumption of growth in the coming quarters.”

Warsh used the word “panic” more than 30 times in his speech -- entitled “The Panic of 2008” -- and said both faulty private practices and flawed public policies were to blame for causing it.

While Warsh did not comment specifically on monetary policy, his speech alluded to one of the thorniest issues facing the central bank: when and how to pull back some of the trillions of dollars that it has pledged to support the financial system.

Some Fed officials have expressed concern that removing liquidity too slowly will trigger a dangerous bout of inflation. But Warsh’s comments suggested he is concerned that the financial crisis may have done lasting damage to the economy’s potential growth, so pulling away supports too soon could throw the economy into a tailspin.

“The panic conditions that have marked this period may also have long-run implications,” he said. “I suspect that the process of an efficient reallocation of capital and labor will prove slower and more difficult than is typical after recessions.”

He said policymakers should be wary of taking action that makes the economy less capable of growth and productivity.

GLOBAL RESPONSE

Warsh said the panic began before the recession “and will assuredly end before it,” but the unemployment rate would likely rise steadily through the balance of the year. Recent economic data was consistent with the view that this recession will be longer, deeper and broader than most, he added.

The breadth of the global slump shows that the financial crisis runs far deeper than souring U.S. mortgage loans and requires a global response.

“There is a global recognition, for the first time in a long time, that this is not about U.S. subprime mortgages. Those who thought this could be contained in one country or in one asset class have been sorely disappointed by the contour over the last six to 12 months,” he said.

“We are in this thing together. This is indeed a global recession and it will be resolved only through coordinated actions across country lines,” Warsh said.

Before the U.S. economy can fully recover, the financial sector needs to be functioning efficiently once again, and greater clarity as to policymakers’ objectives would help to restore faith in financial firms and markets, he said.

“To accelerate the formation of a new financial architecture, the official sector should outline and defend a positive vision for financial firms and welcome private capital’s return,” Warsh said. “The nature and terms of the relationship between financial firms and the official sector should not be left in limbo.”

Writing by Emily Kaiser; Editing by Jonathan Oatis

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