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Pushing string

  • Stephanie Flanders
  • 5 Feb 09, 01:00 PM GMT

It is hurting. But so far it isn't working.

The Bank of England has now interest rates from 5% to 1% since October. Savers say they are being punished for nothing - rate cuts are hitting their income, while having less and less impact on the economy at large.

Bank of EnglandThey have a point. The Bank's Monetary Policy Committee clearly thought this rate cut was worth doing. In its statement it reminded us of its view that "although the transmission mechanism of monetary policy (is) impaired, the past cuts in Bank Rate (will) in due course nevertheless have a significant impact".

It's possible it will cut again before thinking further out of the box than it already has. But there is a rising clamour among some City economists for the Bank to think and act more quickly.

I said yesterday that the major accepted cause of the US Great Depression was the Federal Reserve's failure to prevent a collapse in the money supply after the stock market and financial panics of 1929-31.

For at least a year now, the Bank of England has been trying to avoid that mistake - by pumping liquidity into the banking system and slashing interest rates.

That policy has expanded the narrowest measure of the money supply - cash balances held by banks - and dramatically expanded the balance sheet of the Bank itself.

But, as Jamie Dannhauser at has pointed out, all these efforts have not had much effect on growth of the broader money supply.

That is the measure - known as M4 - that matters if you want to get money moving around the economy and prevent deflation.

Dannhauser says that, once you take account of some big distortions in the figures, the broader stock of money was actually shrinking in real terms in the second half of the year. And it's moving in the wrong direction.

By the Bank's own reckoning, M4 was growing at an annual rate of 3.7% in the third quarter of 2008. It should publish its own estimate of what happened in the last quarter of the year in next week's Inflation Report. But based on the , Dannhauser thinks the annual growth rate for the fourth quarter will be around 1.7% - negative in real terms.

Why do these arcane figures matter? Well, for starters, they help explain why the situation for British companies has deteriorated so much faster than people expected.

Survey after survey finds firms worrying about a lack of cash and working capital, and the figures bear them out.

Money balances in the non-financial corporate sector have fallen nearly 10% in real terms over the past year - despite all the efforts of the Bank.

Today's Bank figures show that the deposits of non-financial companies fell by 拢6.9bn in the fourth quarter, while lending was essentially flat

It brings us back to the old Keynesian phrase about "pushing on a piece of string". The money is going into the banking system but it's not getting through to the broader economy.

Until that happens, the threat of deflation will loom large over Threadneedle Street. And there'll be more calls for the Bank to bypass the banking system, with a big "unconventional" yank on the string from the other side. I'll say more about that big subject in a later post.

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