Thursday, December 06, 2007

Steering into the Skid

Contrasting (and presumably uncoordinated) approaches to the global economic situation.
  • "The Bank of England has cut UK interest rates to 5.5% from 5.75% amid signs that the economy is slowing." [BBC News, December 6th 2007]
  • "President George W Bush has outlined plans to freeze rates on sub-prime mortgages for five years to help people hit by the US housing market crisis." [BBC News, December 6th 2007]
One of the presenting problems has been a credit crunch. But how is a cut or freeze in interest rates supposed to deal with a perceived shortage of credit? Doesn't that just make things worse? After all, according to the simple economics of supply and demand, the normal response to a shortage of something is to put the price up, not reduce it. Or is this one of those paradoxical interventions, where you do the exact opposite of the common-sense action, like steering into a skid.

The difficulty with economic management, of course, is that there are many conflicting purposes and outcomes (inflation, growth, employment, trade, stability), and many conflicting views on how these can best be achieved. Those responsible for managing the economy have to understand the dynamics and governance of complex systems, from which they produce a single headline number - the new interest rate - which is chosen to produce some outcome or balanced compromise between multiple outcomes. Driving the economy around a slippery track, steering into the skid.

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