Word: central
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...good sign, indeed. The Bush administration once saw the decline of the dollar as a boon to U.S. industry. But with investors continuing to bail on U.S. securities and monetary markets Thursday, the question now is whether American intervention alone can turn things around - or whether European politicians and central bankers must also pile on to the euro and help get their creation back in its cage...
...Central banks are supposed to "lean against the wind." Monetary policymakers increase overnight interest rates when strong growth is threatening to push up inflation, and they reduce rates when economies begin to slide into recession and deflation. But what to do when the wind is a cyclone? That is the question confronting the U.S. Federal Reserve, the European Central Bank and their counterparts as the financial storm spawned by U.S. subprime mortgages continues to wreak havoc across credit markets. The resulting higher borrowing rates and tighter credit standards threaten to pull the U.S. economy into recession...
...Such times complicate the standard central-bank playbook - which includes the seminal Taylor Rule. Proposed by Stanford economics professor John Taylor in the early 1990s, the Taylor Rule provides a formula for raising and lowering policy rates based on two variables: whether inflation is above or below the central bank's target, and whether economic growth is above or below its "full employment" potential. If inflation is at target and the economy is operating at full employment, then the Taylor Rule says that the central bank should set the overnight interest rate at a fixed "neutral" level, which Taylor estimated...
...shifting rapidly due to changes in financial conditions, which is exactly what is happening right now. Banks and other lenders are demanding a higher premium for lending to households and companies. To prevent the cost of borrowing from increasing - to keep interest rates at neutral, in other words - the central bank must cut the policy rate. If the central bank wants then to provide monetary stimulus to an ailing economy, it must reduce the policy rate even further to get below the newly depressed neutral rate...
...central bank does not act quickly enough - and deteriorating financial conditions create a self-perpetuating feedback loop with a collapsing economy - the bank may end up just "chasing the neutral rate down" without reaching the level needed to jump-start demand. Japan's experience in the 1990s provides a cautionary tale: even 0% rates failed to resuscitate the economy...