December 8, 2008
Why the Bank of England must fight the economic Blitz in a battle for Britain
Gary Duncan: Economic view
It is the 64-trillion-dollar question. As a fearful nation battens down the hatches, the question that everyone wants an answer to is: just how bad is this recession going to get?
After the Bank of England’s latest dose of economic “shock and awe” with last week’s landmark cut in interest rates to 2 per cent, a level last seen in 1951, a colleague asked me why so much commentary on the new recession harks back to Britain’s last one, in the early Nineties. Having closely tracked the misfortunes of business in that episode, his point was that this downturn already feels much worse.
You can see the point. As dire news piles up, it really does seem like the economy is going into freefall. And that feeling matters, as it saps sentiment and drains away confidence. None of us can be certain how fast, or how far, the economy will slide. So, in trying to weigh the true scale of the danger, it is worth peering back at the lessons of history. Sadly, there are plenty of recessions to ponder.
About 20 recessions in Britain since the mid-19th century and at least 255 across 17 developed economies since 1870 are examined in recent papers by Paul Ormerod, highlighted in research by David Owen, of Dresdner Kleinwort. The findings offer a little comfort – although mainly of the cold variety.
First, the good news. Most recessions have tended to be relatively short and afflicted economies have been able to bounce back quickly. Only 33 of the 255 recessions lasted more than two years and, while nine were calamitous, with GDP dropping by more than 30 per cent, three of those related to the First World War and six to the Second World War. The conclusion is that, with the exception of the two world wars and the Great Depression, developed economies have generally revived fairly rapidly from recessions.
That, though, is where the reassurance ends. Tellingly, wars aside, episodes of recession in Britain since the Seventies have been much more severe than in the 19th and early 20th centuries. Crucially, Professor Ormerod finds that the deeper and longer a recession is, the more feeble the recovery then is. As Mr Owen observes, this takes us straight back to the role of confidence. The faster and more viciously recession tightens its grip, the more confidence evaporates and the more elusive recovery becomes as what John Maynard Keynes called the economy’s “animal spirits” are killed off.
It is just this peril that, more and more clearly, confronts Britain. The new recession has taken hold with brutal speed and severity and the immediate, acute danger is that it will, indeed, prove to be markedly worse than that of the early Nineties. That is why the only thing wrong with last week’s drastic interest rate cut was that it was not drastic enough.
The Bank itself admits that “the downturn has gathered pace”, with “a weaker outlook for activity in the near-term”. It is worth remembering that it was already forecasting that the economy would shrink next year by 1.3 per cent or more – more or less matching the 1.4 per cent slump suffered in 1991, at the nadir of the last recession.
There are at least two powerful factors that leave us at grave risk of enduring something still harsher and which threaten to mean that the economy’s slump accelerates still farther.
The first is the global nature of this downturn, with all the leading Western economies now in a synchronised slump. This is bound to aggravate the toll from recession, with no big economy left immune and able to act as a locomotive to pull the others out of the mire. As Mr Owen notes, global trade is close to collapsing.
The second factor is the pivotal role of the banks, the bogeymen of this crisis, and their continuing failure to play their proper role in the economy and provide a steady flow of lending to businesses and households.
While the banks’ behaviour in curbing lending to safeguard their own financial strength is individually rational, it is collectively crazy and will mean a far deeper and more painful recession unless it is quickly reversed. Certainly, interest rate cuts will help to limit the toll from recession, but, as Philip Shaw, of Investec, observed last week, there is no point in having very cheap money if nobody will lend it to you. While the banks insist that they are keeping up the flow of lending, the data tells a different story.
Taken together, these aspects of the present crisis make Professor Ormerod’s conclusions compelling. The swifter, more radical and more aggressive the action taken now by the Bank and the Treasury to nip recession in the bud, the more the danger will diminish, the smaller the eventual toll will be and the bigger the chances of an eventual, potent return to growth.
The Bank has already taken two giant leaps with the successive 1.5 and 1 percentage point cuts in interest rates over the past four weeks. It can no longer be accused of timidity. Another step will take it into uncharted territory and rates to a level not seen seen in the Bank’s 316-year history. It should take this step soon and make it another big one.
Yet it must be bolder still and steel itself quickly to follow the US Federal Reserve in deploying more unorthodox weapons from the armoury of monetary policy, such as large-scale direct lending to the banks, the buying-up of credit products and other forms of so-called “quantitative easing”. It is vital that it acts now to jump-start stalled activity and to get the lifeblood of bank lending flowing once more.
The historical parallels remain resonant. The last time that rates were cut to 2 per cent was in 1939, a month after the outbreak of the Second World War. Now, as then, the country confronts an economic Blitz. It is time for the Bank to wage a battle for Britain.