Hamish McRae: In a downturn, the Anglo-Saxon approach to interest rates beats rigid Rhineland rules

Yes, but what about the real economy? The shudders going through the financial markets may be trying to tell us something disagreeable about the future direction of the world economy but the evidence coming in on the ground remains reasonably cheering.

In both the US and the UK growth has clearly resumed, pushed by lower interest rates and parts – not all – of the eurozone are clearly growing too. The forward indicators are mostly pointing upwards and the consensus remains that a double-dip to the downturn is unlikely.

Unlikely but not impossible; whether there is now seems to turn on whether very cheap money can carry on stimulating demand. One of the big changes of view that has swept the financial community during the past three or four weeks has been the outlook for interest rates. A month ago the majority view was that there would be successive rises in rates through the autumn, with the bets being that the European Central Bank would go first, following by the Bank of England and with the Fed bringing up the rear. The ECB was thought to be likely to move this month.

Now the view has changed. The plunge in the markets and the improvement in the inflation performance have pushed these rises back to the autumn and there is some talk that the next moves might even be down, not up. If the rates cuts to date do indeed succeed in averting a second dip this will be a triumph for monetary policy, for it will have been used successfully as an instrument of counter-cyclical demand management.

Or rather it will have been used in the US and UK – but not in the eurozone. The contrast between the so-called "Anglo-Saxon" model of capitalism and the "Rhineland" version has been widely noted, though the Rhineland variety is increasingly taking on one aspect of the Anglo-Saxon one, that of heaving out under-performing chief executives as we have seen this week. But there is another Anglo-Saxon/Rhineland contrast, that of the US/UK method of active monetary policy and the more passive method of Continental Europe.

I had not really appreciated the contrast until I came across a speech by Sir Alan Budd, former chief economic adviser at the Treasury and former member of the Bank's Monetary Policy Committee, given to the Society of Business Economists' conference last month and published by CSFB.

He pointed out that the conventional story of the downturn was that the US turned down first and falling demand there dragged down the UK and the eurozone. But that story was wrong, or rather wrong as far as the eurozone is concerned. As you can see in the top graph all three areas turned down at pretty much the same time – the US did not lead the rest into the slowdown – with demand in the eurozone falling most.

In the UK the trade impact was negative but this was offset to some extent by continued high domestic demand. In the eurozone by contrast, trade effects were actually positive; the problem was a slump in domestic demand. In the middle graph you can see how our domestic demand held up while in the eurozone it went negative.

At first glance the policy response to the fall in demand was the same: the US cut interest rates by 3.75 percentage points, the UK by 2.0 points and the ECB by 1.5 points. The difference is not huge but the timing was, for the Fed in particular and the Bank of England to a lesser extent were pre-emptive in their cuts: they moved early in the first sign of weakness. The ECB, by contrast, constrained perhaps by fears of inflation and indeed its statutory duty to keep inflation below 2 per cent, acted more slowly. The difference in UK/eurozone inflation on the preferred European measure is shown in the bottom graph. In addition the ECB had the difficulty of its "one-size-fits-all" interest rate and the fact that several small countries had (and still have) a serious inflationary problem may have further inhibited its willingness to cut rates pre-emptively.

But the difference was not just in monetary policy. Government in both the US and UK went on a spending spree. As Sir Alan pointed out the change in the fiscal position between 2000 and 2002 in the US was equivalent to a loosening of 2 per cent of GDP; in the UK we have swung by slightly more, 2.1 per cent of GDP. In the eurozone, by contrast, fiscal policy has actually been tightened slightly, by 0.3 per cent of GDP.

So there are two completely different approaches to demand management. In the US and UK there has been a deliberate attempt to use monetary policy pre-emptively and as things have turned out, to use fiscal policy as a boost too. In the eurozone monetary policy has been more reactive and fiscal policy has been used almost perversely. So far the active policy has brought better results.

So far – but of course the question remains as to whether the US and UK are now running risks with their fiscal policy. Sir Alan did not really go much into this debate, perhaps wisely. But he reckoned "the US and UK had responded reasonably well last year and one might conclude that they are better equipped to cope with further shocks (positive or negative) in the future."

He also noted that advocates of British entry to the eurozone did not use the argument that it would have a more appropriate macro-economic policy as one of the reasons for joining.

Looking ahead, the question surely is whether the balance of risks from having a really rather strong counter-cyclical policy is greater than the balance of risk in not having one. Anyone puzzled by the markets' gloom needs to run down a checklist of tests, some of which, with some comments, are noted here.

Do, for example, the US and UK risk a revival of inflation? Probably not.

Will the spending plans of the US and UK governments be sustainable? Um, not so sure, but at least both have low public debt levels relative to GDP so in the short-term at least the problem should be manageable. The US has a particular problem of falling tax revenues for reasons that are only partly clear.

Might the external deficit of the US become a really serious constraint, particularly in the light of the dip in the dollar? Yes, of course, always a risk.

Is the eurozone running the risk of a double-dip? Looked at as a whole probably not, but Germany may well be heading into one if it cannot find some way of boosting internal demand. That would be quite serious.

Might the ECB tighten too early? A risk, but one greatly decreased by good recent inflation figures and by the strengthening of the euro. But the ECB is still finding its feet and could make an error.

Put the balance of risks together and I think the judgement of Sir Alan is probably right: that the risks for the eurozone are greater than for the US and UK, partly because the eurozone has performed worse through the downturn so far, and partly because it has less active macro-economic policies. But, fingers crossed, the real economy of both the US and the EU ought to sustain its present improvement. And even if there is a double-dip there will, once that second leg is past, be a steady recovery.

As for the lessons for policy from this downturn – are Europe's quite rigid rules worse than US/UK flexibility? – well, that one will run long after the upturn is really secure.