It is said that desperate times call for desperate measures. Over the past few weeks, the various attempts made by governments and central banks around the world to rescue their economies from the grip of the financial crisis vividly demonstrate the validity of the statement. The US and UK have quickly nationalised large chunks of their financial sector. Germany has done something close to that by guaranteeing all its banks’ deposits. But, even as events unfold from one day to the next, there are strong indications that the interventions are simply not working, going by the responses of equity and foreign exchange markets around the world. The thought foremost in every policymaker’s mind must be: Is there anything we can do to stop the carnage? At this point in time, that is an extremely difficult question to answer and the only possible response of any government can be: if this isn’t working, try something else.
The concerted move by six central banks to reduce their policy rates must be seen in this context. On Wednesday, the US Federal Reserve, the Bank of England and the European Central Bank along with the Swiss, Canadian and Chinese central banks, all cut their benchmark rates. There had been some hint of at least the Fed’s intentions to do this in Chairman Ben Bernanke’s public statements a few days ago that the balance of risks was shifting away from inflation and towards recession. This is quite clear from recent tendencies in the prices of oil and other commodities. The former having dropped below $90 per barrel, down from its peak of close to $147 just three months ago. Food prices, the third driver of the global inflationary surge earlier this year, have also moderated significantly. China was amongst the worst hit in this regard and it has seen its consumer price inflation drop below 5 per cent in recent weeks.
The most telling signs that things are indeed as desperate as they can get is the willingness of the Bank of England and the European Central Bank to effectively forsake their inflation-targeting approach to monetary policy and cut rates; given the prevailing inflation rates, they would not have done so under normal circumstances. The fact that all these banks have acted in co-ordination, with the likelihood that more will follow, has both negative and positive implications. It is an admission that the crisis is well and truly a global one and that US or European intervention alone, however massive, is not enough. On the other hand, the willingness of several banks to act in concert, despite domestic macro-economic conditions not necessarily being conducive, increases the scale of the policy response and, therefore, its probabilities of success.
The most significant aspect of these developments is the shift from targeted infusions of liquidity to save specific institutions, to a broad-based monetary expansion. This changes the equation quite dramatically. With hindsight, one could argue that had this kind of response been forthcoming a few months ago, the circumstances today might well have been different. The Fed cut rates in January, but the rest of the world was too worried about inflation to follow suit. Things are different now and, even if these measures do raise concerns about the recurrence of inflation, they provide the best chance for the system to find its feet again, however groggily.
Oct 10, 2008
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