Tuesday, September 16, 2008

As Crisis Worsens, Central Banks Attempt to Respond, and All Eyes Turn to the Fed

Central Banks Fail to Lift Markets, Financial Times
Wall Street Steady at Open; Fed to Meet, New York Times
As the number of U.S. institution falling prey to the worsening global financial predicament grew in the early week, the financial community’s eyes turned to the world’s central banks. On Monday and Tuesday, central banks in America, Europe, and Asia took aggressive steps (mostly in the form of infusions of cash) to attempt to mitigate the mounting panic and volatility in the marketplace.

In response to increased demand for liquidity by banks, the European Central Bank made available €70 billion in emergency funds. The Bank of England injected £25 billion of cash into the market over the course of the first two days of this week. In a similar move, the Federal Reserve Bank of New York pumped $50 billion into the U.S. market. The Bank of Japan has also let it be known that it stands ready to invest $24 billion to provide needed liquidity.

Unfortunately, these efforts by the central banks have not had a significant impact on the world’s markets. In Europe, London’s FTSE 100, Paris’ CAC 40, and Frankfurt’s DAX were all down sharply on Tuesday, as were Asian indexes including the Nikkei and the Hang Seng.

As central banks’ cash infusions prove, at least in the short term, to be unsuccessful in stopping the market’s decline, the eyes of the financial community have turned to the Federal Reserve. In light of the Federal Reserve’s recent commitment to battling inflation, a cut in the benchmark interest rate has been seen by most as unlikely. However, as circumstances in the marketplace worsen, liquidity becomes more imperative, and the effectiveness cash-infusion strategy employed by central banks early in the week comes into question, a change in the Federal Reserve’s position on interest rates may be forthcoming.

1. Were the Central Banks correct in their cash-infusion approach to the worsening global financial situation? Did they do enough? Do they react with sufficient speed?
2. Is a cut in the Federal Reserve's benchmark interest rate necessary? Is such a cut wise in the long-term?

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