A final push on the piece of string

Bernakegreenspan right.jpg

Yesterday the US Fed cut interest rates to an all-time low of 0% – 0.25%. Once again, Wall Street celebrated with a major rally, even though the move had more symbolic than practical purpose. It made it appear that the authorities were “doing something”, even though the evidence of previous rate cuts indicates they have had absolutely zero effect. The reason is two-fold:

• Back in January, the blog quoted Merrill Lynch’s Richard Bernstein, who argued that “the Fed can lower interest rates quite a lot, but they will likely have minimal impact on the economy unless credit creation grows”.
• Even earlier, in September last year, the blog quoted Rodrigo Rato, then head of the IMF, who argued presciently there was a real risk that “systemically important banks may face constraints in extending credit”. This is exactly what has happened, as banks continue to deleverage.

The only encouraging element in the Fed’s statement yesterday was the implicit recognition that its policy of focusing on massive interest rate reductions has been equivalent to pushing on a piece of string. There is no other way to interpret its conclusion that, after 5.25% of cuts, “financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.”

In admitting it had been wrong, the Fed did leave the door open for a more useful policy to emerge, when adding that it “will continue to consider ways of using its balance sheet to further support credit markets and economic activity”. But “to consider” is not the same as “to act”. There is still no sign that the authorities have yet developed a clear and workable plan for resolving today’s crisis.

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. The aim of this blog is to share ideas about the influences that may shape the chemical industry over the next 12 – 18 months. It will try to look behind today’s headlines, to understand what may happen next in important issues such oil prices, economic growth and the environment. We may also have some fun, investigating a few of the more offbeat events that take place from time to time. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.

, ,

2 Responses to A final push on the piece of string

  1. Robbo 17 December, 2008 at 4:50 pm #

    I guess the arguments between those who believe that the government should get its printing presses out and start buying its own debt, making direct soft loans to institution, etc and the monetarists who need a shake out will only intensify.

  2. John Richardson 19 December, 2008 at 2:52 pm #

    Hi Paul

    The FT piece yesterday gave the impression that the Fed is doing a lot more – and considering a lot more – than just cutting rates such as making loans to financial institutions and lending money to backstop funding markets, such as commercial paper markets.

    Plans are also apparently afoot to buy Treauries in order to keep yields low.

    And if the message remains out there that interest rates are to remain for a long time, this might tackle deflation fears.

    All this could be paid for by printing money.

    But what if inflation comes back with avengeance?

    Chrs
    John

Leave a Reply