Interest rates cut in desperation …


Six central banks have cut their interest rates by half a percentage point.  The US Federal Reserve has cut rates from 2% to 1.5% and the European Central Bank (ECB) trimmed its rate from 4.25% to 3.75%.  The UK trimmed the interest rate to 4.5% from 5%.  The central banks of Canada and Sweden and Switzerland all took similar action in the coordinated move.  China also cut its rate, but by 0.27 percentage points.

The unprecedented step is aimed at steadying a faltering global economy and slumping stock markets.  But will it work?  Does the interest rate have anything to do with the real economy?  Does it bolster trust in the financial industry?  No, not really.  There might be brief relief and a short rise in confidence, but the underlying fundamental picture is not changing.

It is another knee jerk reaction.  It is good to send a signal that regulators are “doing something” but it does not mean it is has been thought out or is the right thing to do.  It is unlikely to help the people least able to weather economic hardship.

What regulators have not admitted is that there is no quick fix.

A resuscitation of financial markets must be underpinned by integrity.  At first this means honest communication.  It might also mean that privately owned banks are required to lend again (eg the UK government acquisition of preference shares might help leverage this liquidity), because without credit well over half of western economies evaporate.

Financial market players also must change their thinking to operate happily in markets of deflation and negative growth.  This means changing metrics and objectives.  These adjustments take time, but should be considered by regulators sooner rather than later.  And have repercussions for all other policy areas.

The saga continues …

US interest rates - how low can you go
EU interest rates up ...

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