The Federal Reserve announced the cut in its benchmark Federal Funds rate from 5.5 per cent to 5.25 per cent at its monthly meeting yesterday in Washington. Many analysts had hoped for a larger cut of one half of a percentage point, and the size of the move disappointed the financial markets.
The move was a sign of the growing concern at the damage wrought to the US economy by the crisis in Asia, the Federal Reserve said. "The action was taken to cushion the effects on prospective economic growth in the United States of increasing weakness in foreign economies and of less accommodative financial conditions domestically," a statement accompanying the cut said.
The significance of the move goes beyond America, however: it shows that concern about the world economy has finally hit home in Washington. The Fed's move comes on the eve of the International Monetary Fund and World Bank meetings in Washington, which will see renewed worries about the world economy. The IMF's World Economic Outlook is expected to show reduced forecasts for growth after the turmoil first in Asia and then in Russia, which risks spreading to other developing countries.
There have been widespread calls for reductions in interest rates, but until now the Fed - the world's pre-eminent central bank - has been unwilling to go along, fearing the impact on domestic inflation.
But it has become increasingly clear that the crisis has also cut economic growth in the developed world, spurring Alan Greenspan into action. Just two months ago, the Fed chairman was more concerned about the risks of accelerating wages and prices than reduced growth, but the tumultuous summer - with a stock market correction, political and financial crises in Russia and the problems of the hedge fund Long-Term Capital Management - has apparently convinced him that conditions have changed dramatically.
There is pressure for others to follow. Paul Martin, Canada's finance minister, yesterday unveiled a plan for tackling economic problems, which put lower interest rates at the top of the list. The international community should ensure "appropriate monetary policy through G7 central banks paying close attention and giving appropriate weight to the risk of a further slowdown in the global economy," he said. The Group of Seven leading industrialised nations are the US, Japan, Germany, France, Britain, Canada and Italy.
"Global growth prospects clearly have worsened, and the balance of risks now lies on the downside. Central bankers now recognise this important fact. They should be prepared to act quickly as risks appear on the horizon or if economic activity slows," Mr Martin's plan said. He was to discuss it last night with Gordon Brown, who was due to arrive in Ottawa.
The Chancellor of the Exchequer will attend a meeting of Commonwealth finance ministers in Ottawa today, which is expected to draw up a plan for tackling the problems of the global economy. Tony Blair and the French President, Jacques Chirac, have already called for an urgent rethink of the world's economic architecture.
There will be pressure at the IMF and World Bank meetings for big changes to the 50-year-old institutions. The IMF in particular has been widely criticised for acting too late in the crisis, and then enforcing punitive solutions against Asian countries, which exacerbated their problems.
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