Four months ago, in September, the Bank of England was debating whether to increase interest rates beyond 5 per cent to counter mounting inflation. There were people who thought that crude oil, then $140 a barrel, would soon fetch $200 or even $250. That world now seems light years away.
As it became clear that we faced a serious recession we Liberal Democrats broke the taboo of the political and economic Establishment by calling on the Monetary Policy Committee to cut interest rates by 2 per cent initially. Our call was treated like a rude noise in church. But it has happened – and more – and we now have a two per cent base rate.
The danger now is of deepening recession mutating into deflation and a downward spiral of falling prices and wages. The Bank of England have to minimise that risk. They should cut further today and keep cutting: the classic response favoured by monetarists and Keynesians alike.
The base rate is, however, becoming a secondary concern in banking and monetary policy. The issue is now the supply of credit more than the price. Despite the injection of capital the banks are on strike. They are cutting lending, even to sound business customers, large as well as small. The Government must break the strike. But it should start by sorting out the confusion and contradictions in its own policy.
It wants banks to lend to business but simultaneously wants its investment back as soon as possible. And it demands that banks hold more liquidity in the form of government bonds: that is lending to Government.
Nor is it sensible to demand that banks pass on the full rate cuts to borrowers. They have to earn a margin on the money they get from deposits or the markets. Even mutuals like the Nationwide Building Society have the same concerns, and they cannot be accused of the sins of shareholder capitalism since they are wholly-owned by their depositors.
In the next few weeks the Government must clarify its objectives and direct the banks which it partly owns and has rescued. It may be that one or more of the big, partially nationalised, banks will have to be taken over fully and become a vehicle for new business lending.
Meanwhile, Barclays' eye-wateringly expensive deal with Arab investors has clearly failed to maintain lending on normal commercial terms, even to big British businesses. They must now begin talks with the Treasury about money.
In the meantime, interest rate cuts are provoking a savers' revolt. It is right to balance the immediate requirement for consumer spending with the need to maintain (and strengthen) a long-term savings culture for retirement, long term care – and mortgage deposits.
Savers will benefit from very low, or negative, inflation; their bank deposits have been given an implicit guarantee by the Government; and some – with money locked into good fixed interest deposits – are doing well. The real scandal is the penal treatment of savings under the means-tested benefit and pension credit system. The Government, in effect, is confiscating savings from the poor and thereby destroying their incentive to save: this is a stupid and cruel policy.
Some worry remains too about the effects of interest rate cuts on sterling. The danger of a flight from the currency has not disappeared. But so far the effects of devaluation have been largely benign – except for those poor souls on skiing holidays or living an expat existence in the Mediterranean sun. Coordinated cuts with the European Central Bank and the US Federal Reserve will help to minimise the risks however.
The big, looming, monetary issue is "quantitative easing": that is, printing money. What happens is that the government borrows from the Bank of England, not from the markets. It expands the money supply to keep the economy going and also to counter deflation without simultaneously increasing government debt. The attractions are obvious, as are the dangers.
The Robert Mugabe school of economics provides a salutary warning about uncontrolled monetary expansion in generating hyper-inflation. The road to Harare is not as long as we might hope. Monetary easing may prove to be necessary but will have to be managed with great skill and care: Too little easing and the crisis drags on – as in Japan. If there is too much, the authorities face the messy task of mopping-up liquidity by issuing bonds which add to the burden of borrowing or else we lurch back from deflation to inflation. So interest rates may soon become yesterday's story.
Vince Cable is the Liberal Democrat Treasury spokesman