A revolution at the Fed?

The current edition of Business Week has a special on Ben Bernanke’s leadership of the US Fed Reserve. As he drives real official policy interest rates into negative territory, this set of articles is good background reading for students in the UK who want to understand a little more some of the differences in approach between the Fed Reserve and our own Bank of England. How big a risk is the Fed taking that its enormous efforts to inject liquidity into the US financial markets and bolster confidence with aggressive rate cuts, will create further problems down the line?

Fed opts to leave a little powder left

It is a sign of the times when a decision to cut (slash) official short term interest rates by 0,75% (taking US rates to 2.25%) comes in below market expectations! The US Fed Reserve has cut the cost of borrowing in a fresh bid to limit the downside risks for the real economy as financial turbulence threatens to dent a huge hole in prospects for the US economy in the coming months. Loads of comment available on this one from virtually every commentator. Evan Davis, the former Economics editor of the BBC was on good form on TV this morning - explaining that cuts in interest rates from the central banks is not really where the problem lies for most consumers. It is the interest rate charged on the lending and borrowing that the banks do between each other which then feeds through into the market for mortgage and other retail loans.

One of the keys to coming out of this crisis will be for banks to recapitalise and improve their own block of funding before they start lending out again. In short, the banks need to attract fresh injections of capital - perhaps from encouraging more of us to save and also from external sources such as the petro-dollars being held by the sovereign wealth funds. Confidence in the different pieces of the financial system is ebbing away - stabilising the markets is the immediate issue and the problem.

Data charts on US and UK interest rates

US_Rate_Cut_March_2008.pdf
UK_Interest_Rates.pdf

Suggested links on the US rate cut

Another cut in US interest rates

The United States Federal Reserve has once more moved to lower interest rates in an aggressive move to bolster confidence and demand in their flagging economy. This BBC news audio-visual clip looks at the immediate market reaction. Just about every macroeconomic policy lever is now being pulled in terms of monetary and fiscal policy and it will be fascinating to see what impact the loosening of macroeconomic policy has on the economy.

Ben Bernanke has indicated that he is prepared to cut rates even further if necessary, a stark contrast to the inactivity at the Bank of England. The fact is that the drivers of monetary policy decisions in the United States tend to err on the side of economic growth whereas the sober bankers on the Monetary Policy Committee take a sterner line on inflation risks. Whose side are you on?