Central Banks Around the Globe Act to Stem Crisis

Central banks around the world acted this morning to stem the credit crisis by cutting their interest rate targets.

The Federal Reserve, European Central Bank, Bank of England, Bank of Canada, Bank of Sweden, and the Swiss National Bank each cut their benchmark rates by 50 basis points. The Bank of Japan, which didn’t participate in the move, said it supported the action, Bloomberg reported.

Separately, China’s central bank lowered its key one-year lending rate by 27 basis points.

The move is a drastic effort to improve liquidity. It also marks a decided turn to an inflationary monetary policy. The joint statement from the central banks specifically addressing inflation, argues that “inflationary pressures have started to moderate in a number of countries, partly reflecting a marked decline in energy and other commodity prices” — meaning that declining commodity prices are offset the massive infusion of capital into the monetary supply. The central banks believe that “inflation expectations are diminishing.” They also see that the “recent intensification of the financial crisis … augmented the downside risks to growth and thus has diminished further the upside risks to price stability.” In other words, the central banks are saying that inflation becomes a non-issue if the global economies decline.

That’s all well and good, but I have heard more than one perspective over the last couple of days that projects the central banks — or at least the Federal Reserve — will specifically seek out an inflationary economic policy. With inflation, the argument goes, consumers can “inflate” out of their housing problems and investors will be forced to acquire assets, rather than avoid investments in favor of cash. It would appear that we are at least heading down that path.

JOINT STATEMENT BY THE CENTRAL BANKS

Throughout the current financial crisis, central banks have engaged in continuous close consultation and have cooperated in unprecedented joint actions such as the provision of liquidity to reduce strains in financial markets.

Inflationary pressures have started to moderate in a number of countries, partly reflecting a marked decline in energy and other commodity prices. Inflation expectations are diminishing and remain anchored to price stability. The recent intensification of the financial crisis has augmented the downside risks to growth and thus has diminished further the upside risks to price stability.

Some easing of global monetary conditions is therefore warranted. Accordingly, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, Sveriges Riksbank, and the Swiss National Bank are today announcing reductions in policy interest rates. The Bank of Japan expresses its strong support of these policy actions.

FEDERAL RESERVE ACTION

The Federal Open Market Committee has decided to lower its target for the federal funds rate 50 basis points to 1.5%. The Committee took this action in light of evidence pointing to a weakening of economic activity and a reduction in inflationary pressures.

Incoming economic data suggest that the pace of economic activity has slowed markedly in recent months. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit. Inflation has been high, but the Committee believes that the decline in energy and other commodity prices and the weaker prospects for economic activity have reduced the upside risks to inflation.

The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 175%. In taking this action, the Board approved the request submitted by the Board of Directors of the Federal Reserve Bank of Boston.

BANK OF ENGLAND

The Bank of England’s Monetary Policy Committee today voted at a special meeting to reduce the official Bank Rate paid on commercial bank reserves to 4.5%. …

In the United Kingdom, CPI inflation rose to 4.7% in August, reflecting increases in food and energy prices. Inflation is likely to rise further to above 5% in the next month or two, in large part as the full effects of already announced increases in the price of domestic energy are felt. But inflation should then drop back, as the contribution from retail energy prices wanes and the margin of spare capacity in the economy increases. Pay growth has so far remained subdued and commodity price pressures have eased, with oil prices down substantially from their mid-summer peak.

Conditions in international credit and money markets have deteriorated very markedly. Many markets are closed. In the United Kingdom, the supply of credit to households and businesses is clearly tightening further as banks seek to adjust their balance sheets. The Committee noted that cuts in official interest rates could not be expected to resolve the current problems in financial markets and that a significant increase in the capital of the banking sector would be required. The Committee therefore welcomed this morning’s announcement of a Government programme to recapitalise the major UK banks.

Data released over the past month indicate that the outlook for economic activity in the United Kingdom has deteriorated substantially, reflecting a sharp monetary contraction. Output growth slowed to a halt in the second quarter, business surveys point to further weakening during the second half of this year, and the labour market has softened. Consumer spending growth has slowed, in part as a result of the squeeze on real incomes, while business and dwellings investment have declined. Equity prices have fallen, and the further tightening in credit conditions will also weigh on domestic demand growth. The depreciation in sterling over the past year should support net exports, but the prospects for demand growth in the UK’s main export markets have worsened. The weakness in output growth at home will open up a growing margin of spare capacity that will over time bear down on inflation.

The Committee remains focused on setting Bank Rate in order to meet the 2% inflation target. In doing so it continues to balance two risks. On the downside, there is a risk that a sharp slowdown in the economy, associated with weak real income growth and the tightening in the supply of credit, pulls inflation materially below the target. On the upside, there is a risk that above-target inflation this year and next raises inflation expectations so that inflation persists above the target for a sustained period. During the past month, the balance of those risks to inflation in the medium term has shifted decisively to the downside. In the light of that outlook, the Committee judged at its October meeting that an immediate reduction in Bank Rate of 0.5 percentage points to 4.5% was necessary to meet the 2% target for CPI inflation in the medium term.

The previous change in Bank Rate was a reduction of 0.25 percentage points to 5.0% on 10 April 2008.