Going It Alone

The gap between the Fed and other big central banks widens. For how long?

Almost as striking as the scale and timing of the Fed’s rate cut on January 22nd was the coolness with which other central banks reacted. The Bank of Canada cut its short-term rates by a quarter point at a scheduled meeting the same day and some smaller central banks that peg their currencies to the dollar followed the Fed’s lead. But no other big central bank did. The Bank of England said it had no plans to bring forward its next meeting, due on February 6th and 7th. Jean-Claude Trichet, president of the European Central Bank (ECB), went out of his way to squash market speculation that it, too, might soon cut rates. “Particularly in demanding times of significant market correction”, he said (to disappointment among investors), “it is the responsibility of the central bank to solidly anchor inflation expectations.”

At one level, this dissonance is no surprise. After all, it is America’s economy that is tipping into recession. Britain has many vulnerabilities—with a big property bubble and highly indebted consumers—but its economy has not (yet) stalled in the way that America’s has. Both in Britain and the euro zone, central bankers are worried about inflation and the prospect of a wage-price spiral.

But the transatlantic gap also suggests sharp differences in dealing with troubles in financial markets. It is striking that the Fed’s rate cut came the day after a swoon in stockmarkets outside America (Wall Street was closed at the time for a holiday). America’s central bankers, it seems, are more worried about tumbling shares in Europe than Europeans are themselves.

Few doubt that America’s central bankers had room to cut. At 4.25%, short-term interest rates were somewhere around neutral, but monetary policy was hardly loose. As ever more figures suggested the economy was stalling, the Fed realised that it needed to step up the pace of loosening—a shift Mr Bernanke had made clear on January 10th. Financial markets were expecting a hefty rate cut on January 30th and several beyond.

It was the timing that raised eyebrows. One rationale was that an unscheduled cut a week before a regular meeting would allow the Fed to loosen rates faster overall. The central bankers’ accompanying statement left the door wide open to more cuts, and financial markets are now expecting a further half-point reduction on January 30th. But the main reason for action this week was to forestall financial-market panic. Fed officials have made no secret of their worries about a “negative feedback” from financial markets to the real economy. They feared more bad news, such as the downgrading of bond insurance, could set off a nasty downward spiral. The risks of such a calamity made them think that waiting until January 30th was too dangerous. Given the global nature of financial markets, that logic suggests there was a case for co-ordinated international action. The trouble for the Fed is that other central bankers see things differently.

Whatever they think of its motives, the world’s central bankers now face a Fed that is in full-scale cutting mode. And the chances are that other central banks will eventually follow suit. The Bank of England is widely expected to cut rates at its February meeting. For all Mr Trichet’s protestations, the financial markets reckon the ECB will cut rates by the summer as Europe’s output slows. If history is any guide, they will be proved right. Other central bankers may decry the Fed’s alacrity at bringing cheaper money, but they usually join it in time.

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