What is the right pace for monetary stimulus following a severe financial crisis? Thursday made it clear there's no consensus: Responding to continued weak financial and economic data, the Bank of England (BOE) cut its benchmark interest rate from 1.5% to a historically low 1.0%, while the European Central Bank (ECB) cautiously declined to change rates, holding them at 2.0%. Essentially, a hop and a skip from across the pond.
The US, UK, and euro zone were the financial crisis' most direct victims, and all currently suffer from largely the same economic problems: a battered Financials sector and declines across business activity. But these similar problems have beget different monetary policy responses. When the financial crisis exploded, all three central banks rushed to guarantee bank assets and provide liquidity by cutting interest rates. In ensuing actions, the BOE and ECB have been more conservative than the US Federal Reserve, with the ECB least aggressive.
The Fed response jumped from one step to the next. Unlike the Fed, the BOE and ECB tread more lightly—neither the BOE nor ECB has yet implemented quantitative easing, though the BOE has put into place programs to allow for it. The differences in policy responses are both ideological and logistical. Both the BOE and ECB exhibited caution last year in lowering interest rates from fear of stoking inflation—both areas have rigid inflation targets. This time around, the ECB hesitated to change rates worrying too-low interest rates would handcuff future policy or send an alarming message about the euro zone economy. The fact the ECB is a central bank representing 16 governments and still-fragmented financial markets also makes monetary decisions more complicated.
At this juncture in the business cycle, there's no certainty which monetary style will prove most effective. Still, the financial crisis' unprecedented depth and severity makes us think a more aggressive and innovative approach is what's necessary now. In this sense, the Fed is clearly leader of the pack, unleashing powerful and new tools to unfreeze credit markets and offset slowing business activity.
To be sure, these central banks and their governments have not stood still, despite moving at disparate paces. It's also key to remember central bank positions are not fixed and can change—sometimes quickly and radically. Central bank and government policies will never be just right, but whether too much or too little is being done now will be revealed in months to come. The market will no doubt alert investors to which policies it views as likeliest to be successful.
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