First Person: Rate cuts not the best remedy

By Ros Altmann, January 14, 2009

The latest interest rate reductions will not stimulate the economy — they may make things worse.

First, such dramatic cuts undermine confidence. When policymakers panic, people reduce spending and retrench, fearing worse to come.

Secondly, monetary policy operates with a lag. A weakening economy does not necessarily demand further rate cuts. If patients fail to recover quickly, the sensible doctor either gives the medicine time to work or changes the treatment, rather than desperately doubling the dose. An overdose could be worse than no action — it could even prove fatal.

Thirdly, there are no guarantees that lower rates will boost lending — the classic case of “pushing on a string”. It is the availability of credit, not the interest rates, that are the main problem.

Fourthly, rate cuts are like cutting the state pension. Millions of pensioners, relying on savings interest, have seen their incomes slashed. Indeed, pension credit means-tests still assume pensioners are earning 10 per cent interest on their savings. This pushes more into poverty, damaging consumption.

The final argument against rate cuts is that it will be almost impossible to reverse them again to avoid serious inflation later. As the financial sector recession will be far deeper and longer than other sectors, there will be huge pressure to retain easy monetary conditions for too long. Will politicians really have the courage to dampen the recovery as soon as it starts?

We need a much better targeted response to this crisis, including direct government lending to businesses, buying housing assets from those about to be repossessed and more help for pensioners in poverty.

Dr Ros Atlmann is a former government pensions adviser

Last updated: 5:18pm, January 14 2009