A final push on the piece of string

Yesterday the US Fed cut interest rates to an all-time low of 0% – 0.25%. Once again, Wall Street celebrated with a major rally, even though the move had more symbolic than practical purpose. It made it appear that the authorities were “doing something”, even though the evidence of previous rate cuts indicates they have had absolutely zero effect. The reason is two-fold:
• Back in January, the blog quoted Merrill Lynch’s Richard Bernstein, who argued that “the Fed can lower interest rates quite a lot, but they will likely have minimal impact on the economy unless credit creation grows”.
• Even earlier, in September last year, the blog quoted Rodrigo Rato, then head of the IMF, who argued presciently there was a real risk that “systemically important banks may face constraints in extending credit”. This is exactly what has happened, as banks continue to deleverage.
The only encouraging element in the Fed’s statement yesterday was the implicit recognition that its policy of focusing on massive interest rate reductions has been equivalent to pushing on a piece of string. There is no other way to interpret its conclusion that, after 5.25% of cuts, “financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.”
In admitting it had been wrong, the Fed did leave the door open for a more useful policy to emerge, when adding that it “will continue to consider ways of using its balance sheet to further support credit markets and economic activity”. But “to consider” is not the same as “to act”. There is still no sign that the authorities have yet developed a clear and workable plan for resolving today’s crisis.