Ben’s bind

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Monday , May 05, 2008 at 2018 hrs The spirit of St Augustine hovered over the Federal Reserve last week. “Oh Lord, let us stop cutting interest rates, but not yet,” is pretty much what America’s central bankers decided on April 30th. The Fed’s governors cut their policy rate by another quarter-point, to 2%. But the accompanying statement gave a small hint that they may now pause.

There are plenty of reasons to stop cutting. Real interest rates are now firmly negative. Although the housing market continues to contract—the latest figures show sales falling, prices tumbling and the number of vacant homes soaring—the economy is limping rather than slumping. According to initial GDP estimates released on April 30th, output grew at an annualised rate of 0.6% in the first three months of the year—the same pace as in the previous quarter and faster than most people expected. The mix of growth was not good. Final sales fell while firms built up their stocks, which bodes ill for future output. But with tax-rebate cheques arriving in the mail, a dose of fiscal stimulus is imminent.

A growing chorus worries that ever lower policy rates are adding to America’s problems. Some prominent economists, including Martin Feldstein of Harvard University and Bill Gross of PIMCO, a big money-management firm, have urged the central bank to stop. Fed cuts, they argue, are doing little to reduce borrowing costs but have sent commodity prices soaring—fuelling inflation and hitting Americans’ wallets hard.

Thanks to the credit crunch, Fed loosening plainly packs less punch than hitherto. Lending standards are tightening across the board. The cost of a 30-year mortgage has risen over the past six months, even as short-term rates have tumbled. But monetary policy has not been impotent. One route through which it has worked has been the weaker dollar. Although the greenback has been sliding for over five years, the pace of decline stepped up as the Fed slashed rates. Since August the dollar has fallen by 7% against a broad basket of currencies and 13% against the euro. Together with strong global growth, this weakness has cushioned and reoriented America’s economy. Strong foreign earnings have boosted corporate profits. Strong exports have countered the weakness in construction. Exclude oil, and America’s current-account deficit has shrunk to an eight-year low of 2.4% of GDP.