If one didn’t know better, it might be possible to think that a page one story today, “Too Much Hope May Be Pinned On Rate Cut.,” was a decent piece of journalism. But to reach that conclusion, you need to overlook a few things.
First, the story is late. Those who were early to recognize the severity of the housing recession anticipated the economy as a whole would suffer. Cutting interest rates probably won’t have much impact on home sales, since the big drivers of this contraction are that prices got out of line with rental price and income levels, and that lenders are retreating rapidly from their overly liberal credit policies. Lowering interest rates at a time of rising defaults is not going to make banks more willing to lend to weak credits.
Second, the article gives the palest version of the thesis, namely, that reducing interest rates won’t stimulate the economy near term:
In the near term, however, the big problem is that it takes months for rate cuts to translate into economic growth, by affecting things such as investment, consumer spending and exports. In credit markets, some banks have become less willing to extend credit for purposes like takeover financing, because of a fear of default. A quarter-point or half-point change in base rates isn’t going to change that very quickly
To support this view, the Journal story quoted two economists, both of whom work for major Wall Street firms.
By contrast, in August, Nouriel Roubini argued that interest rate cuts would have little impact on the credit crunch, since more liquidity won’t solve the problems of insolvency and uncertainty. Lower rates will not make borrowers who have inadequate income and assets suddenly sound, nor will it make banks, skittish about counterparty risk, suddenly secure in trading with each other. And the turmoil in the markets is leading to a rapid tightening of credit, which is bound to deepen and prolong the weakness of the fundamental economy. Similarly as Avinash Persaud, chairman of Intelligence Capital Limited and an emeritus professor at Gresham College, London commented in the Financial Times:
Can lower interest rates temper investor losses? Yes, if the problem is caused by a temporary lack of liquidity; no, if it is caused by a “de-rating” of asset quality, as is occurring today.
Third, if investors have unrealistic expectations as to the efficacy of rate cuts, how have they developed that view? It’s disingenuous for the Journal to report on a problem that it helped to create. We’ve noted before that the Journal has underplayed the severity of the credit crisis, and also put a positive spin on economic news.
And these expectations are a problem. Despite popular beliefs to the contrary, the Fed is one of the least independent major central banks. That means it is harder for the Fed to withstand political pressure. By feeding perceptions that an interest rate is necessary, the Journal, has not just limited the Fed’s options, but also has reinforced the notion that monetary policy can cure our present ills. Economists like James Hamilton have argued that regulatory reform is necessary;
Confidence is a key asset for central bankers. By siding with investors’ wishful thinking, the Journal has set them up to be disappointed, But the Fed’s currency is the one likely to be debased.