Rate Cuts May Help, But More is Needed

The interest rate cuts by central banks from across the world may not even have an immediate impact on the cost of borrowing the money needed by companies to do business, investors to invest and consumers to buy goods.

It takes time before policy-setting interest rates, which form the base of pricing loans, trickle down the financial system and lower the cost of buying a house, your next car or the big flat screen television.

The idea of a coordinated cut in key interest rates was to send a strong signal that central bankers are working together to quell an intensifying panic threatening the world economy.

But there is a dilemma the central banks and government policy makers face whenever they go for deep rate cuts, cash injections and bailouts etc. The financial markets may get the signal, rather clearly, as most bankers and brokers understand the dynamics of monetary policy. But the common man may think otherwise. For a layman, a central bank action is always a grim warning of tough times ahead. And his first response may be to get his money out of the system and into the mattress.

Unfortunately, central banks actions sometime reinforce speculation over imminent bank failures, property market crash or job losses. That is exactly what they are trying to avoid. Interest rates are lowered to ensure that the crisis in the stock market does not filter down to the real economy. Lowering the cost of borrowing ensures companies find enough funds at the right price to keep expanding their operations and keep creating new jobs and consumers continue to buy the assets and goods they need.

Would all the policy actions, some conventional and others not so conventional, avoid a consumer spending crunch? That is what most economists expect is likely to follow.

The central banks may have to do a bit more in engineering an enabling environment for financial markets to work and governments may have to step in to reinforce confidence of the common man in their respective economies. Policymakers usually do a good job in selling dreams. But maybe this time around they’ll have to be honest about the state of the affairs to help stop the haemorrhaging of savings and investments. And they have to be brave enough to take initiatives and enforce regulations to avoid a market segment, the mortgage market in this case, bring the global financial system to its knees.