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Uncharted territory

  • Stephanie Flanders
  • 29 Jan 09, 05:16 PM GMT

"Unconventional" monetary policy is only supposed to happen when official interest rates are at zero and plain old vanilla policies have nowhere to go. So why did the Bank of England confirm today that it was poised to buy up "high quality" corporate debt?

This is not "quantitative easing". Nor is it printing money. But, by the governor's own admission, it is highly unconventional (in fact, he says it's an "unconventional unconventional measure", but let's not go there). And it's despite the fact that official interest rates are still at 1.5%.

One answer is that this is all about confidence, and after playing catch up for so much of the credit crunch, the authorities need to do everything to show they're thinking ahead.

Another is that buying up corporate debt theoretically has a distinct objective - improving the credit environment by reducing the yields in those markets.

But there is a more general point: as the economist David Miles noted in this week's . The Bank may well hope to avoid taking the policy rate to zero - for the sake of the banks.

Their problem is that whenever official rates go down, they are under heavy pressure to cut lending rates in tandem, but many deposit rates are already very low and can go no lower. So margins shrink further, and the banks get squeezed even more than they are already.

The upshot: the Bank of England is likely to be doing a lot of unconventional things long before rates get to zero.

However, a senior economist I spoke to in Davos reminded me that we've heard this argument before - in fact, the Federal Reserve tried the same thing last year. It didn't work.

If the central bank is successful in increasing banks' cash reserves, overnight market rates can go down close to zero, even if official rates are still positive.

The Fed found the anomaly sufficiently uncomfortable that it fairly quickly brought the official rate down too. As it confirmed in , it is going to stay there for a long time.

Economists I've spoken to here think the UK will end up in the same place. But it's possible they will be happy with overnight rates being out of step with Bank rate.

After all, the pressure on commercial lenders is to match "headline" interest rate changes. The mainstream press now pays more attention to the overnight markets than it used to, but it's hardly the stuff of headlines.

Whatever happens, it's uncharted territory for the UK's monetary policy and we are about to step into it.

Biggest game in town

  • Stephanie Flanders
  • 29 Jan 09, 01:00 PM GMT

It started in the US. And that is where it must end.

For all the talk of the rising power of the East, the passage of today's reminds us that some things haven't changed.

The very absence of US policymakers from Davos tells the story. None of them are here because they're too busy saving the world.

In 10 or 20 years' time, the world economy will probably have other engines it can turn to when American demand starts to falter. But right now, we are still all chained to the buying capacity of the US.

. Their complaints about the US are today festooned on the .

Having caused the crisis, the effectively suggested the Americans should show a bit more humility in deciding the best way out.

Igor Yurgens, a senior advisor to the Russian president, took a sharper tack. He said President Obama's stimulus package was "selfish" and philosophically akin to .

Bill ClintonBill Clinton is the closest thing Davos has to a senior US official this year and he responded pretty directly at a packed session this morning.

"The Chinese PM is right. It all started in the US." But, he said, the only way out was through a US stimulus, and that depended on other countries buying US debt - primarily countries like China that are "export-dependent, cash-rich but hurting."

The world needs the Chinese to stimulate their domestic economy to help fill the gap left by collapsing US demand. But I doubt that any Russian or Chinese policymakers seriously want the Americans to sit on their hands.

At the heart of the spats with the US is a more basic frustration that the dollar's status as the world's reserve currency means that, yet again, America is getting a free pass.

Governments all over the world are plunging into deficit to get themselves out of this mess. And the more profligate they were in the past, the more they are paying the price in the form of a falling currency. Witness what's happened to the pound.

But not the US. Because it is the world's reserve currency it can flood the world with US debt, and the dollar barely falters. It has even risen a little today.

It's not fair. And it may change. But for the moment, America and its currency are the biggest game in town.

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