One way to look at the American Federal Reserve’s interest rate cuts announced last week is through a prism of medical metaphors. First, prevention is better than cure. This is the first Fed funds rate cut in four years; the discount rate cut is the second in six weeks. Critics have called the Fed’s pre-emptive actions a very broad tool to fix a very specific problem. The cuts in policy rates — the Fed funds rate at which banks borrow from each other in the overnight market, and the discount rate at which banks borrow from the Fed itself — have two effects: on consumers and on financial markets. Following the Fed’s announcement, banks and financial institutions have announced cuts in their prime lending rates, which are tied to interest rates on credit cards, auto loans and mortgages. Consumers in the United States of America carry about $800 billion in credit-card debt, and the rate cut will save them about $4 billion in interest rate charges, and hopefully keep them spending. The desired impact on mortgage markets is not as certain: about half of all US mortgages are linked to the 10-year US Treasury bonds, yields on which have been rising even after the rate cut. Interest rates will also be reset on about 2 million sub-prime loans starting January 2008, more than half of which are linked to the London Inter Bank Offer Rate, which has remained stubbornly high. Will the attempt to shock the patient back to life work?

As signals from the financial markets threaten the larger economy, business spending is likely to be affected; to keep investment and job growth steady, the rate cuts must keep credit flowing. If credit tightens, banks will lend less, and hold loans on their books longer. The discount rate cut encourages banks to borrow from the Fed, and is a signal to keep lending. From $4 billion a week in August, daily borrowing by banks and financial institutions from the Fed went up to $7 billion last week.The dollar has fallen against every currency. This is bad news for foreign investors, whose holding of US securities is crucial to the debt-heavy US economy. Retail food inflation has gone up by 4 per cent in the last year, gold futures have reached a 25-year high, and yields on 30-year bonds have risen sharply. It will be months before the full effects of the Fed’s rate cuts work their way through the economy. That is when it will be known if the cure was worse than the disease.