How About a Coordinated Rate Cut Tonight?

October 7, 2008

The separation by central banks of their targeted liquidity-pumping efforts from stabilization monetary policies made conceptual sense until recently.  However, new realities call for fresh thinking, and there is little time to waste.  Credit markets are no longer suffering from just a lack of liquidity.  Big institutions have failed, mutual trust is lacking among survivors, a global recession has begun, and the longer-term price scenario to be feared most has switched from inflation to possible deflation.  Dysfunctional money markets have damaged psychology, hurt real economic demand, and in turn are imposing added strain on the marketplace.  The crisis has spread geographically to most developed economies and threatens to engulf emerging markets.

The Fed’s new facility for funding the commercial paper market is one of the best policy initiatives to be conceived, yet fear was not lessoned.  The markets’ reaction to a good gesture underscores how dangerous the situation has become.  A coordinated rate cut, involving Australia last night, the Bank of England on Thursday and inter-meeting moves by the Fed, ECB and others can be justified by changing forces on future inflation and is needed to substitute hope for fear.  Politicians ought to play an inspirational role in this task, but unfortunately most elected leaders are now held in low regard.  Central banks need to step into this vacuum.  When anti-inflationary medicine is warranted, analysts are inclined to advise that action be taken sooner, lest much more drastic measures be required after delay.  The same reasoning applies here, only in reverse.  It has become apparent that actions that would have produced a favorable response if taken by early summer, are not doing the job now.



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