KEY POINTS:
Tomorrow the Reserve Bank is due to make its monthly review of interest rates and there is not much doubt it will cut its official cash rate again. The only question is whether it will slice a full percentage point, as in November, or 1.5 points as in December. Until a few months ago movements of this magnitude were unknown; the bank controlled the economy with just a touch or easing of the brakes by 0.25 or 0.5 of a percentage point depending on the inflation outlook.
Brakes are an effective means of control of a vehicle with momentum, they are less effective at restoring momentum when the vehicle has practically stalled. The bank's drastic reductions of late have made no discernible difference to economic activity and nor will a similar cut tomorrow. The bank is no longer controlling economic activity, it is reacting to the reductions of others, ensuring that interest rates here are not left too far above those elsewhere.
Central banks everywhere have been rendered ineffective by recession. Their base rates can barely influence even retail bank rates when lending is at such a low ebb. Trading banks are lowering their lending rates at their own pace, reflecting maturing deposits and the lower rate at which they can borrow. With property and stock markets still in the doldrums, bank deposits remain the most popular refuge of personal investment.
It probably will not matter, now or in the long run, whether the Reserve Bank lowers its cash rate to 4 per cent or 3.5 per cent tomorrow. Inflation has been the sole concern of monetary policy and inflation has disappeared. New Zealand actually experienced deflation in the last quarter of 2008. The Consumers' Price Index fell 0.5 per cent in those three months, which will probably encourage the bank to make the greater of its predicted cuts tomorrow.
A rate as low as 3.5 per cent would leave the bank still with some room to cut further, for what that might be worth. The United States has no such latitude left. The US Federal Reserve has cut its rate to a range of zero to 1.5 per cent and is casting about for new ways to respond to a still deepening recession. Its policy-making body, the Federal Open Market Committee, meets tomorrow to review the effectiveness of steps so far taken and to examine new options.
Those are likely to involve the provision of easier credit for business and consumer spending. Central banks in many countries may need to take up much of the provision of new capital for business if their trading banks do not soon pass on the ample advances they have been given by their governments.
Too many trading banks in the US and Europe seem to be using the public money to cover their losses on bad lending in the boom years, rather than lending it out to business customers. New Zealand and Australian banks are said to be in a healthier state and no shortage of business credit is apparent here.
Likewise, the Reserve Bank was a good deal more alert to the risks of the housing bubble in the middle years of this decade. If the US Federal Reserve had taken a similar view in those years, the bubble might have been contained and the US economy might not have crashed as it has, taking others with it.
Recriminations can wait, revival is the urgent need. It will not be found in monetary policy. Government spending and lending are probably needed to carry economies through the worst. Monetary policy has proved highly effective in keeping economies running on low inflation. But a vehicle is only as good as its driver, and monetary policy is useless when a booming economy has been allowed to spin into a ditch.
Interest rate reductions will not restore the economy's traction but at least they will not hinder its recovery when it comes.
