Rate cuts to deter recession
By William Keegan
LONDON: With the Bank of England's quarter point reduction in interest rates on Tuesday to 4.75 percent, the initial round of central bank moves to alleviate a potential world economic crisis is complete. On Monday the U.S. Federal Reserve (Fed) led with a half point reduction to 3 percent and shortly afterwards the European Central Bank (ECB) followed suit also with a half point cut to 3.75 percent.
With each day that has elapsed since the terrible terrorist attacks of Tuesday Sept. 11, it has become more and more apparent that the economic slowdown was already pronounced even before this additional huge blow to economic confidence administered by the terrorists.
The financial impact of the attacks on airlines and tourism is already dramatic, and unlike the case after the Gulf War in 1991, the impact on airline travel is likely, for obvious reasons, to be more long lasting.
But the big question is how the terrorist attacks and the aftermath will affect consumer confidence, which, in the United States at least, was already very low. The omens are not good and the 7 percent fall in Wall Street on Monday was a fair indication of the general nervousness. And that was on a day when the big speculators and hedge funds were under orders from regulators to be on their best behavior
The world's financial system has so far coped well with the problems caused by the terrorist attack. Both the front and back offices on Wall Street did amazingly well in handling what turned out to be a record day's business within six days of the terrorist attacks.
The central banks have also done well, injecting billions of dollars of liquidity into the markets to prevent interest rates from being driven up by artificial or temporary shortages of funds. Coordinated central bank moves on this front have kept the financial system going. And the interest rate cuts are aimed primarily at maintaining -- or restoring -- the confidence of business and consumers, in the hopes of averting a recession.
After its long expansion and all the fantasies about a "New Economy" the U.S. economy had already slowed to the point where it looked increasingly difficult to avoid outright recession. It needs to slow down because the boom had become more and more dependent on unsustainable increases in consumer debt with a correspondingly dangerous rise in the U.S. trade deficit.
But experience suggests that, once the attempt is made -- as the Federal Reserve did towards the end of last year -- to slow down an economy, it is a difficult art to avoid overdoing it. Likewise, monetary easing to control a downturn has often proved to be next to impossible to get right.
Thus, while the Fed's cuts and strong international leadership are to be welcomed, there is no guarantee its moves will be sufficient to counteract the strong recessionary tendencies in the United States, and hence the world economy as a whole. It is worth noting, for instance, that so far the tax cuts by the Bush administration have reportedly gone largely to reduce consumer debt rather than to revive spending.
Again, the cut by the ECB is to be welcomed. It is the first time the ECB has altered rates because it is worried about the prospects for economic growth, rather than justifying a change solely in regard to the inflationary implications.
As for the Bank of England, a quarter point change is hardly sensational, but then, although slowing, UK growth has been higher this year than in the United States or the Eurozone, and consumer spending in particular has been buoyant.
The central banks may deny that these moves are formally coordinated, but to all intents and purposes they are.
One place where there will not be much coordination in the next two weeks however is at the annual meetings of the World Bank and International Monetary Fund (IMF), which have been canceled in the wake of the terrorist bombings. Ironically, the IMF news came after the decision of the protesters against globalization to call off their demonstrations in the light of the terrorist attacks.
-- Observer News Service