Fed rates cut in US shows limited effect of its firepower

Cantillon: Post-recession economics leave little room for central banks to intervene

Federal Reserve chairman Jerome Powell: Share prices rose in the immediate wake of the cut and then quickly fell.

Federal Reserve chairman Jerome Powell: Share prices rose in the immediate wake of the cut and then quickly fell.

 

What happens when the sheriff runs out of bullets?

The decision by the US Federal Reserve Board to cut interest rates by 0.5 of a point shows the limited firepower of the world’s central bank in responding to the economic impact of the coronavirus.

Share prices rose in the immediate wake of the cut and then quickly fell – investors will calculate that interest rate cuts are not addressing the key problems caused by the coronavirus crisis.

The Fed, at least, had some room for manoeuvre, having raised its rates after the economic crisis. Still, its base rates were already low and are now hovering over 1 per cent, with investors already pricing in another cut.

The European Central Bank, meanwhile, has left its base interest rate at zero and the deposit rate it offers to banks is already in negative territory. Nonetheless the Fed move will put the ECB under some pressure to act when its governing council meets next week, with a significant risk of recession hanging over the euro zone economy in the first half of this year.

Liquidity issues

In truth, governments rather than central banks have a more important role to play in the economic response, as well of course as in public health measures.

Government budgets may need to be loosened to increase health spending and to help companies and employees hit by the crisis. Central banks, via their regulatory role for the financial sector, should be ready to press banks to help companies hit by short-term liquidity issues – and may be able to provide some liquidity to the system to help. But there is a limit to what they can do.

Central banks were forced to cut interest rates again and again during and after the economic crisis.

The strange shape of the recovery – with generally low economic growth and very low inflation – has meant they now face into the next threat without the ability to cut rates by much.

Lower borrowing costs can help to support demand to some extent – and perhaps underpin confidence – but with the world awash with liquidity the price of money is just not the key issue.

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