Why the Fed and ECB need to make bold interest rate cuts
As the world holds its breath over the imminent war in Iraq, the problems in the globe’s three largest economic zones are much deeper than those created by the threat of war. Undoubtedly, the prevailing uncertainty casts a long shadow over the plans of businesses and consumers. This is well attested by surveys of the continuous upheaval and unstable orientation of capital markets and the ups and downs in the parities between the dollar, euro and yen. Much worse, it also stands to be confirmed by the economy’s main and long-term indicators. However, it is not evident in the policies of most European governments, including Greece’s, that they are preparing for such a gloomy scenario. Germany and France are shying away from bold measures. Greece’s Prime Minister Costas Simitis appears persistently «absent» from the multiple complications emerging in the drive to maintain satisfactory growth rates in the economy. Largely the same applies on the other side of the Atlantic. The Bush administration is basing its hopes on a package of tax breaks on dividends – a controversial measure in terms of both social justice and the confidence it could create in the prospects of the American economy. It has become evident that governments are neither able nor willing to push through measures for restructuring their economies, cutting expenses and boosting employment. The return of politics to center stage has made the economy more cumbersome to support. But central banks, too, appear hesitant, almost absent. The recent, 0.25 percent cut in the basic rate for the euro will bring only small benefits. Commercial banks show no intention of passing on the cut to their clients and are likely to support only limited debt rescheduling schemes. An increasing number of economists believe that the global economy is entering uncharted territory. Almost no one restricts himself exclusively to analyzing just the dangers related to the military operation against Saddam. They recognize that the war promises to further burden an already ailing global economy, drifting rudderless and leaderless. The only thing supporting the large economic entities today is the continuance of consumption at stable levels. If consumers cut down on spending, the economy will suffer further even if governments implement demand-boosting programs. However, it is reasonable to expect that a war will send fear of the day after rocketing among consumers. This is particularly so if the war proves to be long and complicated or is followed by other upheavals. A drastic fall in consumption will multiply the problems of companies, as it will have a prohibitive effect on their efforts to get out of the financial straits they find themselves in. The rates of the main currencies – practically meaning the dollar and the euro – will have to be cut now, speedily and boldly. The Fed, due to meet this week, is likely to consider a further cut in its basic rate which already stands at 1.25 percent, especially if war gets under way. The European Central Bank will find it difficult to confirm its stated intention to make «small and careful» steps, not bigger than a 0.25 percent cut. The careful – and not necessarily pessimistic – analysts note that now is the time to make decisions that will affect the European economy for more than the next six months. We could not agree more.
