A Global Attack on a Global Demand Deficiency

November 26, 2008

Acting in their own interests and based on local economic prospects, more central banks cut interest rates today. The biggest move was a 108-basis point reduction in China’s lending rate to 5.58%, matching the cumulative cuts of 27 bps each on September 15, October 8, and October 29th. The People’s Bank of China also slashed its deposit rate by 108 bps, or 30%, to 2.52% from 3.60%, and reserve requirements were reduced by another 100-200 basis points varied by  the size of the bank. 216 basis points of easing since the Lehman failure in mid-September was prompted by slowdowns in Chinese export, import, and industrial output growth, weakening money expansion, and a World Bank prediction that Chinese GDP will advance at a 19-year low of 7.5% next year.

Two days ago, Hungary’s central bank sliced its base rate by 50 basis points, reversing in small part a 300-bp rate hike on October 22nd. A statement released by the Magyar Nemzeti Bank cited worse home and abroad growth prospects, a downwardly revised inflation forecast, and IMF aid that reduces risks to the forint currency and associated with funding external debt.

The National Bank of Poland followed suit today, cutting its rates for the first time since February 2006. CPI inflation of 4.2% is above the 2.5% target but now decelerating, and the path of reduction will be steeper in light of weakening domestic and foreign demand as well as the plunge in commodity prices.

The central bank in Georgia cut its refinancing rate today by 100 basis points to 9%, and Ukrainian reserve requirements were reduced on foreign currency deposits and eliminated for local currency deposits.

The EU Commission today approved a fiscal stimulus for its 27 members of EUR 200 billion, roughly 1.5% of GDP that will temporarily rescind Stability and Growth Pact limitations on deficit spending.

This past Monday’s British Pre-Budget Statement embodied a stimulus package amounting to about 1% of GDP. Reviews of it have been guarded. For the economy that is forecast to experienced the sharpest recession in the G-7, a stimulus of that size looks insufficient, yet Britain’s public finances were already in poor shape, limiting the prudent maneuvering room for fiscal support. The Bank of England will have to shoulder the bulk of the macroeconomic response. If a liquidity trap develops, such will not be very effective.

The Fed unveiled two more facilities for boosting credit yesterday, amounting to $800 billion, setting the stage for its balance sheet to balloon next year to more than $3.0 trillion. Crisis management is about putting out fires that threaten to destroy everything and often sows the seeds for another, and sometimes greater, long-term threat. The Federal deficit likely will exceed 7% of GDP next year, greater than its biggest relative size of the 1980’s. On the other side of the U.S. recession, it will be imperative to reabsorb the fiscal and monetary stimulus in a timely manner to limit long-term damage but not so hastily as to abort recovery. In an L-shaped recession like Japan experienced in the lost decade of the 1990’s, that never proved possible. In a more recent example involving the Fed earlier this decade, the central bank slashed its key rate by 550 bps to 1.0% but raised them subsequently in increments of 25 basis points stretched over two years. That gradualist approach never threatened the expansion but nurtured the housing bubble and other imbalances that produced the money market meltdown of 2007-8. The Fed has got be willing to ratchet rates up at a faster pace, but Chairman Bernanke, an academic authority on the Great Depression, believes one of the big policy mistakes of that era was lifting rates too quickly once scope for higher rates emerged. It may be that no middle ground exists. Either Scylla or Charybdis, the monsters that blocked Ulysses’ passage, is going forestall a happy ending.

Tags: ,


Comments are closed.