I watched in bemusement as the RBA took its time lowering rates in 1990. They’ve been much better this time. Still, it all looks pretty odd to me. We know things have changed. There seems to be general consensus that rates should and will fall further. The formula from a week or so ago was an ‘expectation’ that there’d be two 0.5% cuts. In fact the cut was 0.75%.
But it seems to me quite clear that the risks are all on the downside on growth, so why don’t we take the interest rate to where we think it should be as soon as possible. John Hewson suggests a rate with a three in front of it (I read and remember agreeing with a recent AFR column of his but it’s behind a pay wall so I can’t check the figure he suggested).
Things are more crook in Brittain where the Bank of England has just caused a stir by cutting by 1.5%. But Samuel Brittan, one of my favourite economic journalists and at his best on monetary policy, thinks it’s not enough:
The “bold” 1.5 percentage point cut in official interest rates announced by the Bank of England is barely adequate and will probably need to be followed by further cuts soon. . . . [T]hese are not normal times.
The big difference in diagnosis is between those who still think in terms of a conventional business cycle . . . and those who believe that something more apocalyptic has happened. For this first group it is important to worry about the size of the current budget deficit, re-establishing fiscal guidelines in the medium term and the maintenance of an arm’s length relationship between governments and central banks. . . .
At the other extreme are those who believe we are now in a new game . . . and that a successful demand stimulus can influence the future output trend and not merely fluctuations around it. Central banks and governments need to co-operate to provide this stimulus. Inflation is a rapidly receding danger and central bankers who worry about inflationary expectations setting off a wage-price spiral are like the proverbial generals fighting the last war. . . .
Critics say that Alan Greenspan’s reduction of the Fed funds rate to 1 per cent in 2003 sparked off the recent credit bubble and its subsequent collapse. They do not say what else should have been done to prevent Asian savings surpluses from generating a world depression. But even if it is conceded that Mr Greenspan went down too far for too long, Mr Bernanke now faces a radically different situation in which the very existence of the US and world monetary systems has been threatened.
Not long ago the Bank of England might have been said to be somewhere in between the two camps. But recent utterances, even before yesterday’s cut, have placed it nearer the revisionist one. For instance, Mervyn King, the governor, has said that “not since the first world war has the banking system been so close to collapse” and that the “economic news over the past month has probably been the worst in such a period for a very considerable time”. Why then has the monetary policy committee not immediately slashed the Bank rate to somewhere near the US Fed funds rate, now again at 1 per cent? The normal argument for gradual changes is uncertainty about the course of the economy. The only uncertainty now, however, is about how far the UK recession will go. On present evidence it looks deeper than either the US or the eurozone one. The only plausible argument against moving down by several percentage points at a time is the sense of panic it might generate. One response might be to move down in a series of frequent steps – which would mean abandoning the Bank’s self-imposed timetable of monthly intervals between changes. . . .
Many analysts fear that central banks will soon have “run out of ammunition” because official interest rates cannot fall below zero. This is the famous “zero interest rate bound” known as ZIRB to its friends. Mr Bernanke, then a Fed governor, showed that this is not the case in speeches during the 2002-03 deflation scare. To begin with, central banks can expand the range of securities in which they deal, as they are to some extent now doing. But the ultimate weapon would be a fiscal stimulus financed by money creation – the equivalent of the famous helicopter drop. You could call this monetary policy made effective, or fiscal policy supported on the monetary side, according to taste. If you are too hidebound to countenance this move you deserve to run the risk of a severe slump.