Sunday, March 8, 2009

Another round of rate cuts!

The European Central Bank and the Bank of England cut rates to 1.5% and 0.50%, respectively, last week.

Not all are thrilled. Including Prof. Willem Buiter of the LSE over at the FT in his blog.

Prof. Buiter is becoming sort of a worry wart of sorts. But, he does raise interesting points. The main point for example is that: "It is certainly not helpful from the point of view of getting the banks to use the additional reserves they hold to boost their lending, that the Bank of England has reduced the opportunity cost to commercial banks of holding large reserves, by eliminating the 25 basis points penalty on the operational standing deposit facility."

There is always a danger that when you cut a rate, it has an adverse effect on other rates and industries depending on stable rates. And, on the flip side, you counteract and do the opposite to what you have intended--like Buiter's case.

In his case, the clear issue is that when you lower rates to allow bank's to have more stand-alone capital, through discount windows and other lending agreements, you would lower the rates for the operational standing deposit facility, increasing their demand for short term capital and a cheaper rate--to then, be able to send it back at less the cost. With, still, no increased lending to the average consumer.

Misguided inflation, while not an example expressed by Buiter in this case, is also something that can have many different deflections indeed.

Perhaps the excess in short term liquidity, is supposed to tamp down long term hyper-inflation, while increasing banking confidence to lend responsibly, with increasing the exchange possibilities and avenues to greater capital and liquidity?

I think the issue is keeping the bank's moving, as opposed to keeping them stagnant--zombie-like--without risk of increasing money supply and incurring hyper-inflation.

In any event, in a nutshell, once banks are losing money and the economy the way that it is, expect the rates in the UK to go to zero.

The ECB may not go that low. But, who would have thought that we would have such a financial collapse.
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