Monday, January 19, 2009

New measures to support the banks have been announced today by the government. A key component of these is the creation of a system whereby, for a fee, the government insures banks against bad debts. This requires the banks to declare and agree with the government the sums that they expect to lose from existing debts. As a quid pro quo, the banks will be required to guarantee that they will increase lending to businesses and individuals.

Any support that encourages the banking system to return to normal lending is welcome. However, the success of these measures will depend crucially on how effectively they flush out hidden information. It is not at all clear how the authorities will incentivise the banks to come clean about the true scale of bad debts. In the absence of this information, there is a sense of floundering.

Wednesday, January 14, 2009

Today's announcement of government support to small businesses is welcome. The support takes the form of insurance which will protect banks making loans to small and medium sized businesses, and will pay out in the event that the businesses are unable to repay their loans. The amount of government funding that is being committed to this scheme, at £20 billion, is likely, however, to be too small to meet the need, and the scheme will therefore need to be expanded pretty soon if it is to be successful.

The new policy attacks one of the problems facing small firms - access to credit to finance investment. There are, however, other problems. Many small businesses find that, as recession grips the world economy, demand for their output is depressed. This is a problem that requires a different solution - and it is not a solution that one country alone can provide. Various countries independently are now considering a substantial fiscal stimulus. Coordinated action would be to all countries' benefit.

Tuesday, January 13, 2009

The latest monthly estimates of GDP growth from the National Institute of Economic and Social Research indicate that growth in the last quarter of 2008 was -1.5%. This represents a truly alarming slump in economic activity - one that calls for urgent and very substantial fiscal injection.

Thursday, January 08, 2009

The Bank of England has reduced its official bank rate of interest to 1.5%, a cut of half of one percentage point. This follows several dramatic cuts in the last few months of last year, and reflects a continuing perception that further stimulus is needed to reinvigorate the economy.

That perception is, of course, right. The economy is stagnating although the traditional levers of policy have already been pulled in an attempt to mitigate the worst effects of the downturn. One is certainly tempted to ask whether the traditional tools of policy, not least important of which is the interest rate are broken. This is a question that I have asked on this blog before - if banks are rationing lending, perhaps the price of credit is not so important. Perhaps government should intervene directly to stipulate that banks, at least those in which it has taken a large financial stake on the public's behalf, should lend a prescribed minimum of their assets.

This is an important question, but it is just that - a question. Policy takes time to take effect. It is still far too early to conclude that the interest rate cuts of recent months have not been effective. Indeed, given the lags that are inherent in the macroeconomic system, we would need to wait till the middle of this year before we can even begin to reach such a conclusion.

Unfortunately the economic situation is serious enough to make policymakers impatient for the answer. For that reason, there is now more and more talk of alternative policy instruments - including direct government intervention in bank lending. As the interest rate heads towards zero (1.5% is the lowest it has ever been), consideration of the alternatives inevitably comes to the fore.

Monday, January 05, 2009

Leader of the Opposition, David Cameron, has today called for taxes on savings to be scrapped. The cost of this would be borne in the form of lower public spending.

This seems a curious response to the current economic situation. The savings ratio rose steadily through last year, no doubt helped by the gap that has opened up between interest rates on the high street and the Bank of England's rate. There may indeed be a case for the interest on savings to be taxed at a higher rate than at present, with the revenues of such a tax hike being used to subsidise high interest payments on business loans. Likewise the proposal to reduce public spending seems perverse. During a recession, this would be destabilising. As I argued in this blog on 25 November last year, there are reasons to think that the government's handling of the present situation - and in particular the VAT cut - has not been particularly smart. But Mr Cameron's response seems to offer the worst of all possible worlds.