The world?s central banks launched a new offensive last week by lowering short-term interest rates in an attempt to help curb the current financial crisis. The chief threat of the global financial crisis is the hoarding of cash by banks and other financial institutions. The holding of cash is making it difficult for households and business to finance day-to-day operations.
On Wednesday, October 8th, the Bank of England, U.S. Federal Reserve, and the European Central Bank cut the interest rates by 0.5%. Following this move were the Banks of Canada and Sweden, as well as the People?s Bank of China, and the central banks of Australia, Taiwan and S. Korea. This is the first time that central banks across the Atlantic have moved in tandem since the September 11th, 2001 terrorist attack in the U.S. that threatened the global economy.
The move came after a Tuesday morning conference call between Jean-Claude Trichet of the European Central Bank, Mervyn King of the BOE, Mark Carney of the Bank of Canada, and Ben Bernanke of the Fed. The call also involved Masaaki Shirakawa of the Bank of Japan, who did make cuts due to his unease over already low interest rates. The call resulted in the decision to cut interest rates because of the recent stock market plunge and tightening credit crunch.
The hope is that the cut will stimulate bank borrowing by decreasing the costs to banks, businesses and households. However, a decreased rate does not assuage the fears of loaner default; particularly with the pending $700 billion bail out of ?toxic? assets by the U.S. government, and the plans for a £250 billion buy up of assets by the Bank of England.
The efforts of the central banks were made in hopes to prevent the credit freeze from crippling the global economy. However, former Fed governor Laurence Meyer stated, ?For all central banks, this is not the end of the story. We are facing a potentially severe recession.? Most investors are expecting further interest rate cuts in the Euro, UK and the US, depending on how the market performs in the future. Currently, the FTSE is experiencing losses. This is a common development to the stock markets worldwide, as the Dow Jones in the United States is also experiencing losses.
The Bank of England hopes stimulate the economy by buying up assets and pumping £200 billion into money markets. Gordon Brown hoped to distinguish England?s move from that of the current crisis in the U.S., saying the investments being made ?will earn a proper return for the taxpayer.? The decision to lower short-term interest rates to 4.5% is coupled with movement toward partial nationalisation by the Bank of England.
The meeting of the International Monetary Fund later this week in Washington D.C. may provide new ideas for the coordinated efforts of the world banks. However, it is difficult to align international politics of taxation and spending, despite the ease of manipulating interest rates.
The potential worst-case scenario of the cut in interest rates arises as the interest rates approach zero, the central banks lose their ability to stimulate further growth. The central banks were previously worried about the rise in interest rates due to inflation. However this recent emergency cut to interest rates shows an abrupt change in their way of thought, at least for now.
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