Will lower interest rates help?

A reader has kindly sent me an interesting analysis from Richard Bernstein, Chief Investment Strategist at Merrill Lynch (ML)*. He argues that ‘the Fed can lower interest rates quite a lot, but they will likely have minimal impact on the economy unless credit creation grows’.
Bernstein says their research indicates that US credit availability is now very tight. This leads him to conclude that ‘the Fed’s policies might be extremely impotent’ and akin to ‘pushing on air’. He adds that ‘lower interest rates do not always spur credit growth’, and points to the example of Japan for the past 15 years.
I noted back on 9 September that the then IMF head. Rodrigo Rato, had also warned that reducing interest rates might make the situation worse, not better. Rato argued that the real problem was that ‘systemically important banks may face constraints in extending credit.’ Four months later, it seems even more likely that the current lending crisis is about concerns over return of capital, not return on capital.
This analysis had led me to question whether ‘cutting rates (would) encourage lenders to lend more?’ I concluded that the answer was ‘Probably not. It might well make them more reluctant, by reducing their potential reward. It might also weaken the dollar, as overseas investors looked for higher returns elsewhere’.
Unfortunately, developments over the past 4 months seem to suggest that my concerns were correct. Key US chemical markets such as housing and autos have got worse, not better, whilst the US$ has weakened.
Another round of US rate cuts is widely expected this month. Although the Fed is undoubtedly well intentioned, ML’s research suggests that their actions may, in this crisis, be doing more harm than good.
(* I can’t link to this report, but will be happy to send a copy to any interested reader)

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