Will more rate cuts around the world save us from recession? SmartCompany Q&A

The desperate global fight to keep the economy from slipping into recession continued overnight, with the US central bank cutting official interest rates there by 0.5% to just 1% and China’s central bank cutting commercial loan rates by 0.27% to 6.66%.

The desperate global fight to keep the economy from slipping into recession continued overnight, with the US central bank cutting official interest rates there by 0.5% to just 1% and China’s central bank cutting commercial loan rates by 0.27% to 6.66%.

The Reserve Bank of Australia is widely tipped to cut official rates by 0.5% to 5.5% when it meets next Tuesday, just half an hour before the Melbourne Cup, while central banks in Britain and Japan are widely expected to cut rates the coming weeks.

What is the objective of these rate cuts? Can they prevent global economies from sliding into recession? Time for a quick SmartCompany Q&A.

So the US Federal Reserve cut rates again last night. What are they hoping to achieve?

Like previous rate cuts, this cut is aimed at speeding up the process of thawing out credit markets and getting banks lending to each other and businesses again. However, the motive behind the cuts has changed slightly.

Rather than being emergency rate cuts designed to help stabilise the global financial system, these cuts are designed to help cushion the real economy (that is, businesses and households) from a deep and ugly recession.

Are the cuts working?

Sort of. Certainly credit markets are thawing, with the key London interbank lending rate (the rate at which banks lend to each other) falling for 13 consecutive days. However, the US economy continues to hurtle towards recession, or something worse.

Overnight, Martin Feldstein, the former head of the US National Bureau of Economic Research, told a German newspaper that the US economy is headed towards the biggest recession since World War II and will need a massive government stimulus package. Good luck with that, Obama.

US rates are at 1%. That doesn’t leave the US Fed with much room to move, does it?

Not really. Over the last 13 months, the Fed has cut its official overnight rate from 5.25% to 1% in nine separate steps, and says it is prepared to keep cutting if necessary. Business Spectator’s Alan Kohler suggests today in his column that the Fed may have to start cutting the rates of other Treasury debt instruments, such as two-year Treasury bonds. But as Kohler also points out, the closer rates get to zero, then the Fed has no real way to stimulate economic growth.

Hmm, let’s hope these latest rate cuts work then. What’s happening in Australia?

Most economists expect the RBA to cut rates by 0.5% when it meets next Tuesday and then follow that up with another 0.5% cut in December as part of a rate cutting cycle that will see the official cash rate fall to 5% or even 4.5% by the middle of next year.

Sounds great. I could do with a bit of relief from the mortgage.

Well, it’s not all good news. This sort of accelerated rate cutting cycle is a clear signal that the RBA is trying to insulate the economy from a possible recession.

We’re not heading into a recession, are we?

The likelihood appears to be increasing by the day. While most economists are still predicting economic growth or around 1.5% or 2% next year, JP Morgan chief economist Stephen Walters has tipped Australia will slide into a technical recession (two quarters of negative GDP growth) in the first quarter of 2009, as economic growth over the whole year falls to 0.7%, with unemployment hitting 9%.

Walters is predicting economic growth of 2.5% in 2010 as the household and business sector enjoys a modest rebound, but he warns the business community could take a long time to recover from the financial crisis. “Many managers, though, shell-shocked by the global financial crisis and the lingering impact of the global recession, may be reluctant to restart stalled investment projects, which limits the extent of the rebound,” he says.

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