Economists say doing nothing was not an option in a climate where confidence was eroding, writes Barry O'Halloran

THE US central bank "doesn't exactly know where to put the firewall at this stage", IIB chief economist Austin Hughes says.

Hughes argues that the collapse of Wall Street giant Bear Stearns and the ongoing fall out from the credit crunch are only serving to highlight the complex relationship that global financial institutions have with each other.

Once upon a time, he argues, a central bank could predict easily enough what would happen if it acted, or did not act, in a given situation.

But the US Federal Reserve - or Fed - has found itself in a new situation, and while it is trying to deal with it by taking what seem to be logical steps, it can't be sure that they will have the desired effect.

At around 6pm our time yesterday, the Fed announced it was cutting its basic and inter-bank lending rates by three quarters of one per cent, its latest response to the newest twist in the credit crisis that has been gathering momentum since last August.

Hughes and other Irish economists say any impact the cut might have depends on whether the move will give US banks the confidence to start lending to each other again.

Goodbody economist Dermot O'Leary points out that the bank has already cut rates by 3 percentage points in the space of six months. "But it can't force the banks to lend to each other, that's the big difference here," he says.

Pat McArdle of Ulster Bank agrees and says the Fed has found itself in a classic situation of being able to lead the horse to water, but not being able to make it drink.

They also agree that doing nothing is not an option. Rossa White of Davy stockbrokers, says that the move will ease some borrowers' pain and should prevent the US from slipping into the depths of recession.

But if it fails to have any real impact where it is most intended, what then? The economists all point out that Fed chairman Ben Bernanke has said that, if necessary, he will take "unorthodox and creative" steps to deal with the crisis.

Hughes suggests that these could ultimately result in private-sector liabilities being carried by the public purse.

From an Irish and European perspective, the Fed's cut means a further weakening of the dollar against the euro, with an obvious impact for any exporters selling to the US.

McArdle says these businesses will face a tough time. He's not hopeful that the European Central Bank will ease their pain any time soon by cutting its lending rates.

"The ECB will not respond with a cut of its own," he says. "They will want to see the numbers coming out of the euro zone, and while inflation is still growing, they won't move. That will lead to a tightening of conditions here."

However, O'Leary believes that the ECB will have to recognise that not cutting rates poses a risk to economic growth, and so will cut rates faster than many of his colleagues say.

Whatever the central banks do, confidence in the global financial system remains central to the problem. "It's less what the average person on the street believes than the confidence that banks have to lend to each other," Rossa White explains.

He adds this confidence could still be shaken over the coming months, which means that it depends on global financial institutions not having too many skeletons left in their closets.

"I'd like to think that we are into the second half, but it could go on for some time."