Leading article: A proportionate response


The guardians of the American economy have been stirred to action. The US Federal Reserve cut interest rates again yesterday, the third time it has done so this year. These cuts are designed to defuse two clear and imminent threats to the health of the US economy. The first is the collapse of the property market. The sickness of the notorious "sub-prime" sector has spread to the rest of the market. House prices are tumbling and Americans are finding it increasingly difficult to shift properties. The second danger is the continuing "credit crunch", which has clogged up the international money markets. The Fed calculates that a modest relaxing of monetary policy will send a reassuring signal to the property, equity and credit markets, easing the slowdown that most analysts agree is taking place in the US economy.

This is not without risks. Some argue that cutting rates is a gamble because it is likely to weaken further the international value of the already stricken dollar. At a time when global commodity and oil prices are soaring, thanks to rising demand in fast-growing economies such as China and India, an even weaker dollar could stoke domestic inflation in the US. The counter argument is that the US economy's slowdown will negate these inflationary forces anyway and that it is misleading to think in terms of the Federal Reserve being forced to make a "choice" between growth and inflation. The two are inextricably linked.

The other criticism of the Fed's rate-cutting concerns our old friend "moral hazard". If borrowers are conditioned to believe that the Federal Reserve chairman, Ben Bernanke, will ride to the rescue in a panic by slashing interest rates, what incentive will they have to keep their borrowing within prudent limits? And is not the credit crunch one of the spectres hanging over the US economy a result of too many bankers and borrowers bingeing on easy credit?

This second argument is more difficult to answer. It is true that the Fed, under its previous chairman, Alan Greenspan, helped to pump bubbles in the property and credit markets through an aggressive policy of cutting interest rates in the wake of the internet stock market collapse of 2000, and before. But it is still possible to defend the Fed's more recent behaviour. Rates have not been cut to anything resembling the ultra-low levels of 2001-2004. Bankers and borrowers should learn a tough lesson, regardless of the Fed's latest manoeuvres.

So far, the response to the slowdown from the Fed and our own Bank of England has been proportionate. But it is important that they do not go too far in their efforts to cushion our economic landing.

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