The following economists’ answers appear in no particular order.
DeAnne Julius, Chatham House and former MPC member
The main risk, as I see it, is the lack of funding for the commercial sector (not housing). This is driven by 2 sources and to prevent it, action is needed on both. First, banks need to continue their deleveraging process and this reduces their appetite to lend. Government prompting alongside recapitalisation is already underway to counteract this, but only time will tell if enough is being done. Second, as the economy worsens, the credit risk that banks face from (especially small) business loans grows. Government guarantees for a portion of these loans can offset this, but only if the cost of those guarantees is kept low and funded mostly by the tax-payer rather than banks or businesses. The UK government has been especially tight-fisted in the terms it has offered its banks for assistance. This may yet backfire.
Philip Booth, IEA
- further problems within the banking system leading to collapse in monetary growth; a collapse in confidence in the medium term ability of the government to fund its spending without huge increases in taxation; a loss of consumer confidence worldwide
Mike Wickens, York University
The main risks are that the policy responses will prolong the recession. The biggest risk comes from fiscal policy. Fiscal policy, already far too loose for many years, is now a complete mess. The fiscal rules have been thrown away and we are in uncharted territory. Recent fiscal actions have shown that the government is floundering. A second risk comes from monetary policy. Like fiscal policy, monetary policy is also in uncharted territory. A second risk is that current monetary policy is unlikely to be effective. Certainly I don’t think it will be effective as the spread between the repo rate and bank lending rates is too big. It is like pushing on a string. The third risk is that both fiscal policy and monetary policy will be too loose for too long and will act to destabilise the economy in the longer term.
Douglas McWilliams, CEBR
In one word, very….
There is one major risk, which is that confidence, particularly in the financial community, does not recover.
But this will be affected by whether the authorities get it right. So far they have got very little right, and those things that they have got right like the bank refinancing package and the VAT cut have been done too late or too timidly. If they fail to sort out the toxic loan problem next year then the UK recession will be deeper and will last longer
Tim Leunig, LSE
The big risk is that government will do something very silly. Governments could become seriously protectionist (although I doubt that anyone would engage in protectionism to the extent of being in violation of the World Trade Organisation rules). The government also could waste a great deal of money. Some people (not me) believe that we do need a discretionary fiscal boost, but it is important that that fiscal boost is spent on things that will have medium term productive benefits for the economy. Building bridges to nowhere, Japan’s style, is not useful.
It is very likely that governments become so obsessed with fighting short-term battles that they neglect the long-term economy. In the long run what matters is productivity growth, and it is important that governments think about this. There is now increasingly good evidence, for example, that the demand for university graduates, particularly ones with quantitative skills, is extremely elastic. This implies that there are strong returns to society from increasing the supply of these graduates. What is government doing about that? The Eddington report showed that the benefit to cost ratio of a major programme of road building was more than five to one. What is the government doing about that?
What we do in Britain is not going to be the biggest determinant of whether we get a world recession, or even whether Britain gets out of a recession first. But what we do in Britain is going to be the biggest determinant of how well placed Britain is to be a successful economy in the next 25 or 30 years. Government must not stop thinking about skills and infrastructure: these are things that are very much within government power to do something about, and things that government should be doing something about.
People whose jobs are vulnerable should be very concerned. For the rest of us the recession will make little difference. It has been reported that financial Times journalists have been put on a pay freeze. But since the price level is going up by approximately 0 this is a nuisance, but it is not exactly the end of the world. Indeed for many people, particularly with safe public sector jobs, the standard of living rises in recessions since there are more sales on. In general this recession is likely to favour the young at the expense of the old. The young are more likely to be in debt, or wanting to buy a house. Both of those groups will benefit, conditional on not losing their jobs. For those who have already paid off their mortgage the fall in interest rates is unwelcome, and for those who wish to sell their house to pay for nursing home fees, the current downturn in the housing market is extremely bad news, both in that the price they get will be lower, and they may have difficulty selling their house at all.
Jonathan Loynes, Capital Economics
I would view the three main risks as a severe contraction in bank lending, further sharp falls in asset prices, and a further deterioration in the international environment. The first of these will render the recent aggressive loosening of monetary policy largely useless and severely restrict the availability of credit to both households and companies. Further falls in asset prices – especially house prices – will add to the pressure on consumers to rebuild their balance sheets by paying down debt or increasing their savings. And further weakness overseas will prevent UK exporters from benefiting from the drop in the exchange rate.
Jonathan Haskel, Imperial College Business School
1) expects of rising taxes in the future. High concern, we know it’s the case.
2) government stimulus money wasted on low return projects. Also high
3) restrictive employment legislation exacerbating the recession. I think the employ ment legislation that makes it so hard to hire/fire potentially mires firms in massive legal issues when they try to downsize. The way out is to declare bankruptcy rather than partial workforce reductions and all the accompanying paperwork. So I think we’ll see much steeper job loss than would otherwise be the case.
4) if I can add, protectionism as a response to job loss. Medium risk.
Oliver Marc Hartwich, The Centre for Independent Studies
1) A Labour government after the next election (spending more without knowing how to finance it).
2) A Conservative government after the next election (wishing to spend less without knowing where to cut expenditure).
3) The reduced ability of the Treasury to issue bonds if the expectation is that the pound slumps further.
Michael Artis, Uni Manchester:
Continuation of the present inaction in Germany might cause trouble as the German market is important to the UK; then, it has to be admitted that the severity of the credit crunch is unprecedented and confidence is low - low enough to be independent cause of further recession.
Stephen King, HSBC
The first risk is money hoarding which, in turn, leads to deflation….and deflation, in this case, could easily become Fisher style debt deflation. The second is a possible further deterioration in the uk’s credit rating if more bank bailouts are required: uk bank assets are huge relative to the tax base, leaving the uk more exposed to the banking crisis than its peers. Third, although it’s already fallen a long way, there remains the possibility of a major sterling crisis.
Nick Bosanquet, Imperial College
The main risks are all internal rather than from more external shocks:
1) Loss of confidence in sterling financial assets brought about by low to zero interest rates and further increase in government borrowing. This will lower value of asset base and further worsen credit crunch, hence the threat of a credit grind.
2) The reduction in competition and increase in cartelisation in the banking sector will reduce the credit base.
3) There will be a growing consensus that UK faces special problems of stagnation.
John Calverley, Head of research, Standard Chartered
I already expect that house prices will go down much further still in the US and UK (and elsewhere). I already expect that there will be “headline” bankruptcies among major companies and more frauds coming to light. I already expect that there will be social and political fall-out but hard to know where and when. I also expect that governments will need to put more capital into banks in the US and probably the UK. The risks beyond that are therefore, first that many people still do not realize that this is a one-in-forty years experience – the last real crisis period was the mid 1970s. Asset prices, particularly stocks may not have fully priced that in yet so there may be more pain to come. Second risk is that international cooperation breaks down and we see competitive devaluation and/or protectionism. Third risk is some sort of new outside shock - perhaps over Iran, or North Korea or something completely unexpected.
Alan Budd, Provost of Queen’s College, Oxford, former chief economic adviser to the Treasury in 1990s and MPC member
Very concerned that industrial and commercial firms in the UK and around the world will be forced to sack people and cut investment drastically in an attempt to restore liquidity. The attempt will fail if everyone is trying to do it at the same time.
Patrick Minford, Cardiff Business School
The main risk is that the momentum of the downturn already in place can be underestimated. However, there has been such hyperbole used to describe our current situation that this seems unlikely; the monetary policy reaction is very large.
The second risk is that we will overdo the policy response, particularly on the fiscal side, and generate too sharp a subsequent upturn, much as in 2001-3. This is a larger one.
Andrew Scott, London Business School
1) A big recession means high levels of corporate defaults. The subsequent rise in non-performing loans and pressure in CDS market will put further pressure on bank balance sheets which are only just recovering from the MBS shock.
2) Government bond market tensions. With a flight to safety sovereign bond prices have risen strongly. With uncertainty about future fiscal plans and fears over cross-border coordination, especially in Europe, it seems likely that 2009 will see tensions in some government bond markets.
3) Political risk. Rising unemployment will cause social tensions and pressures on governments to focus on social rather than economic issues. This will decrease the efficiency of stabilisation policy. The world is rediscovering an appetite for risk – so lets through in national and international conflicts/bad tempered relationships.
Dieter Helm, New College Oxford
The three main risks are: a further sterling crisis; a sharp contraction of capital expenditure particularly in the utilities and infrastructure; and the government resorting to the printing presses.
George Magnus, UBS
The principal risk is that of policy failure. Governments will have to persevere with banking system support, ensure good borrowers get access to credit, and use public programmes to stimulate aggregate demand over the medium-term. Central banks will have to utilise forms of quantitative easing, working hand-in-glove with the fiscal authorities. The second major risk is outright, rather than temporary deflation, which would generate another wave of asset price falls, and greater economic hardship. The third could be protectionism and acrimony among nations, arising from the failure of surplus countries, such as China and Germany to boost demand to compensate for the deleveraging in deficit countries.
David B Smith, University of Derby and Beacon Economic Forecasting
The first risk is clearly some unexpected and catastrophic geo-political event, such as a war between India and Pakistan that goes nuclear, or some horrendous terrorist outrage.
The second risk is an outbreak of US protectionism. President-elect Obama and a Democratic controlled Congress both appear to be significantly more protectionist than the Bush administration. This really would revive the spectre of the notorious Smoot-Hawley tariff and the Great Depression. From a geo-political perspective, it is also worth bearing in mind that one cause of the upsurge in Japanese militarism that culminated in the attack on Pearl Harbour was the fear that Japan was being cut out of world markets and needed its own ‘co-prosperity’ sphere to sell into. The US oil embargo was the final straw causing the Japanese to go to war. It would be a horrendous mistake to repeat the same error with China, but one has to be concerned that it could happen.
The final worry is that the near universal resort to ‘crass-Keynesian’ fiscal policies will lead to a collapse in aggregate supply, slowing economic growth, and ballooning budget deficits. There is an associated risk that there will be a sharp rise in real and nominal bond yields at some point. This development would hit savers even further because of the resultant capital losses, and could cause governments to get into a debt-interest trap, leading to sovereign defaults in OECD member countries, such as Greece.
Andrew Simms, New Economics Foundation
Three main risks that could profoundly exacerbate the recession are:
1) A failure to re-engineer our banking system, which developed with an excessive focus on high finance, and is now revealed to be ill-designed to meet the banking needs of a UK economy built on small and medium sized enterprises.
2) A failure to make available the low-cost capital needed to kick start the Green New Deal. The government can, of course, lead in several ways: through direct spending with its own resources, through influencing the investment policies of the recently nationalised banks, and by encouraging new vehicles for saving and investment such as green bonds.
3) In addition to the still-unfolding credit crisis, risk comes also from the other two sides of the ‘triple crunch’ triangle. External shocks from climate change and the energy sector are major threats. A repeat of last years upheaval in the global food markets, pushed by a combination of a food infrastructure already hollowed-out by the big supermarkets, and weakened by climate change, geopolitics and speculation could make more trouble, as could further volatility in the energy markets.
Howard Archer, IHS Global Insight
1) Poor policy responses; 2) financial crisis proves extended and even deepens, and banks don’t lend; 3) increasing beggar-thy-neighbour policies, including protectionism.
Given the extremely poor and delicate state of the global economy, people should be very concerned. It will not take much to exacerbate the recession.
David Frost, British Chamber of Commerce
1) If bank lending doesn’t return to some sense of normality the wheels of the economy cannot turn effectively.
2) A lack of confidence in the business community to expand, invest and take on staff.
3) Good companies being lost to the recession that will never be replaced.
People should be wise to how the recession could affect their own situation, especially considering that we haven’t seen anywhere near the full extent of the downturn yet. It is important to remember that we have been in a recession before and come out of the other side - we will do again.
George Buckley, Deutsche Bank
1) The risk that funding for increased government borrowing proves difficult to obtain at current gilt yields and levels of sterling. The risk remains that interest rates could rise and sterling fall further going forward.
2) Rising unemployment looks set to continue into 2010, and risks perpetuating the recession. Unemployment rose by just over 1m in the 1990s and close to 2m in the 1980s. A repeat of the latter would have devastating effects on household consumption and thereby GDP.
3) While deflation is not our central scenario, the prospect of falling prices might lead to consumption being deferred, in turn making the downturn more pronounced. The mere publication of the RPI inflation series - which will (artificially) fall very sharply into negative territory early on in 2009 - may influence consumers to withhold spending.
Robert Barrie, Credit Suisse
The biggest risk in our view - and the one that justifies the policy response - is that the recession is an almost completely synchronised event around the global economy. In the past, an economy that was in recession could export something to someone who wasn’t. That’s not possible this time. There are other serious questions such whether the banks will lend, or whether consumers will spend, but it’s easier to imagine us solving those. I think most people are probably aware that we are in recession by now - a quick call to the bank will probably clear up any confusion on that score - and that many will have adjusted their spending accordingly. Hopefully there is not too much more bad news to come on that score.
David Page, Investec
These are inter-related, but
1) Measures undertaken by the domestic and international authorities are insufficient to alleviate the credit crisis. Monetary transmission mechanisms remains blocked and monetary stimulus does not have intended impact on wider economy.
2) Debt markets (both at home and globally) become concerned at huge levels of issuance and push yields higher (this may be associated with large surplus economies, such as China, switching from purchasing international sovereign debt to try to stimulate domestic economies). The associated rise in yields chokes the central banks’ attempts to keep yields low to stimulate the economy and fails to incentivise longer-term borrowing for household or corporate spending (housing or business investment).
3) Concerns over UK’s recession, household and government debt positions continues to depress sterling. The drop in the currency begins to dissuade capital inflows from overseas - precipitating risk 2.
Charles Goodhart, London School of Economics and former MPC member
USA and Asia revert to protectionism.
Iran test fires a nuclear bomb.
Keith Wade, Schroders
The main risk is that the economy does not respond to policy. The banks keep credit tight despite the actions of the Bank of England and households save the proceeds of the VAT cut. The failure of the economy to recover could then prompt a loss of confidence and further collapse in sterling.
David Miles, Morgan Stanley
The main risk we see is from household saving behaviour. There is a risk that households try to increase their savings by a large magnitude and sharply rather than gradually. That would likely imply a very sharp contraction in consumption. A second main risk would be from ’adverse feedback loops’ developing, for example asset price falls, the slowing economy and rising unemployment making banks less willing to lend and households and corporates less willing to spend. All this worsens the outlook for the real economy…
Richard Jeffrey, Cazenove
The principal risk is that banks continue to rein in lending, and that measures to improve liquidity do not get through to the non-bank private sector. This would raise the probability of recession turning into deflation.
A second risk is that companies and households become increasingly risk averse, preferring to reduce financial deficits (or raise surpluses) before increasing consumption/investment. This very real risk would reflect a swing of the pendulum from an extended period during which households, in particular, built up a huge financial deficit through a combination of over-consumption and heavy investment (mainly in the housing stock). This situation may be associated with a higher liquidity preference - the result of maintaining a policy regime characterised by exceptionally low interest rates (i.e. low interest rates do not act to stimulate consumption; rather, they encourage higher levels of cash saving).
A third risk is that a depreciating pound prevents the expected fall in inflationary pressure from coming through to high-street prices. This would call into question the policy strategy now being followed, and could also result in a period of negative real earnings growth. In turn, this would deepen the recession raise the risk of deflation.
Ross Walker, Royal Bank of Scotland
1) Lending to PNFCs deteriorates. I am relatively unconcerned about mortgage lending - housing valuations remain very high on any conventional benchmark so one pre-requisite for a sustainable recovery in mortgage lending is for house prices to fall. A resumption of mortgage lending to reflate house prices will do very little to bolster real value added. By contrast, if credit channels to the corporate sector fail to function in some normal fashion, there will be an unnecessarily severe blow to the UK’s wealth- and employment-generating base. The UK economy is already suffering from the ”Bacon & Eltis syndrome” - the last thing it needs is even fewer producers.
2) Globally, a failure to begin to engineer policy shifts to rebalance global growth. Or, put another way, a continuation of dangerously misguided mercantilist policies - this really shouldn’t be happening almost a quarter of a century after Adam Smith exposed this folly in The WoN.
Peter Dixon, Commerzbank
In my view, the key to the length and depth of the recession is what happens in the labour market. If companies are under such pressure that they start to slash the labour force dramatically, we could be looking at a downturn not far short of the early 1980s in terms of severity. A second risk is the actions of the banking sector. If credit does not begin to flow through the economy again quickly, firms will come under major pressure thus exacerbating the labour market problems. Finally, the UK problems will be magnified by the extent of the global downturn. If this threatens to be the worst global recession since WWII, it is a pretty safe bet that the UK will take a serious hit. Bear in mind, however, that the recession may actually feel worse than it is precisely because we are coming off a period of great economic stability. Unlike the early 1980s, we are not “used” to booms and busts in the economic cycle. Should we be concerned? Yes. But people have always survived recessions in the past and they will this time around.
Diane Coyle, Enlightenment Economics
First, the possibility still that the banking collapse will affect everyday payments systems; secondly, the complete evaporation of trade credit and loans for normal working capital requirements; thirdly, protectionism and the kind of self-fulfilling downward spiral which made the thirties so awful. All are unlikely to materialise on balance but the implications are absolutely awful if they do.
Karen Ward, HSBC
The first risk is the degree to which unemployment will rise. We cannot be sure how much buoyant credit contributed to the growth in both GDP and employment in the UK in the past ten years. Roughly half the UK labour force work in construction, finance, business services and retail. As we move to a more prudent world, how many of these roles will no longer be required? The second key risk is that deflation takes hold. With the highest debt in the G7, the damage of a deflationary spiral is acute. There are fewer nominal rigidities in the UK labour market than there are elsewhere in Europe which also means the chance is higher. There are already instances where workers are accepting nominal pay cuts. The third risk lies further ahead and relates to the eventual recovery of the UK economy. By then enormous stimulus will have been imparted. One of the lessons from the low interest rate policy in the US earlier this decade is that if policy stimulus is not withdrawn promptly once recovery takes hold, the consequences can be profound as markets search for yield.
Ruth Lea, Arbuthnot Securities
The most important risk is the restriction in bank lending as banks seek to repair their balance sheets (in the teeth of a sharp recession), cope with tighter regulatory requirements and cope with the dramatic loss of wholesale funds.
The second most important risk is a prolonged global recession – especially in the USA.
The third is the possibility of deflation – which I am less concerned about than some commentators appear to be.
People, including the Authorities, should be very concerned indeed. The Authorities (Treasury and the Bank) are now indicating that they are concerned.
James Knightley, ING
1) Further bank losses/ hedge fund collapses leads to more market uncertainty & worries over whether governments can finance bailouts - interbank rates rise again, putting up borrowing costs. At the same time, equity markets plunge - renewed negative wealth effects, more job losses etc.
2) In the UK a sterling crisis is possible - major worries about how the UK will finance the deficit, capital flight etc. Not a nice story for the UK economy
3) Geopolitical tensions & protectionist measures. As the global downturn intensifies in more and more countries tensions could mount and politicians start playing the blame game more aggressively.
Patrick Foley, Lloyds TSB
The biggest risk for the economy is that extreme risk aversion persists in financial markets and that this restricts the availability of credit. Without a return to lower spreads, the cost and availability of wholesale funding (rather than capital) will continue to be the principal constraint on banks’ ability to support a recovery. However, governments and central banks realise this, so I would expect to see major initiatives in 2009 to increase the supply, and reduce the cost, of wholesale funding. The other major risk is that a sharp slowdown in world trade, allied to concerns about important industrial sectors, will persuade governments to become more protectionist. I expect very weak world trade to cause major problems for trading nations like Germany and China. A potentially severe recession in Germany would put significant pressure on the eurozone and a sharp slowdown in China would be a cause of political unrest. If China resorts to currency depreciation as a way out, this will be bad news for the world economy.
David Owen, Dresdner Kleinwort
Despite quantitative easing, banking crisis continues to worsen, bank lending really does collapse. Emerging markets fall into deep recession, pushing everyone back down. Tariffs/trade restrictions worsen global downturn.
In the UK and US big risk is a multi-year rise in the saving ratio.
Also note that the longer the recessions go on, the less likely recovery becomes if animal spirits die. And the oil price may play a pivotal role. Say it rises significantly as tentative signs of recovery occur. Could distinguish or push back recovery.
Gerard Lyons, Standard Chartered
1) The biggest risk is a prolonged collapse in lending. And this is linked directly to the problems overhanging the banks. Take the housing market. The fall in house prices and collapse in interest rates has boosted housing affordability, but few can take advantage of this, as banks are not lending because they expect prices to fall, thus loan to value ratios are lower, and few potential buyers can raise funds. If the banks are not lending, the government should, with direct lending. This could be through a national lending or investment bank. In terms of housing, it should be recognised that the present situation risks a self-feeding downward spiral. If the government was to lend directly then there would need to be some sensible criteria, so as not to burden the taxpayer by nationalising risk. Such criteria could be borrowers need an unbroken employment record for three years, a 10% deposit, and then the government should lend to first time-buyers. If they don’t the present fall in house prices could become a slump. A similar approach could be adopted with small businesses. Although people and firms tend not to want to borrow in a recession, the worry at the moment are the stories that sound businesses, with decent order books, are facing a shortage of working capital and cash flow problems.
2) A big problem is a loss of confidence in the economy and a loss of trust in the banks. In this situation, even those with the ability to spend and invest will not do so. This justifies the policy measures to date, and points to the need for even more direct action. The outcome of a financial crisis depends on the economic fundamentals (which are poor), the policy response (which is impressive) and confidence (which has been shot to pieces). It is important to try and stimulate demand and hope that this changes expectations about the outlook.
3) The biggest risk is pro-cyclicality. When in a hole the best thing to do is stop digging. Ease capital requirements on banks.
People should be concerned.
But don’t ignore the upside risk! The biggest surprise might be if the huge policy stimulus around the world, combined with the sharp fall in oil and commodity prices, allowed the world economy to rebound stronger and sooner. I would like to think this, but more likely these policy measures and commodity price moves will help, but will not be enough to prevent the global downturn.
John Philpott, Chartered Institute of Personnel and Development
When participating in the equivalent FT exercise a year ago I likened the credit crunch to a tumour in the financial system and said that 2008 would prove if it was benign and merely troubling or malignant and potentially fatal. Sadly, autumn brought the formal diagnosis.
The first main risk to the economy, globally and nationally, is that we still don’t know if we are over the worst and if there are any further surprises in store. Who a year ago seriously forecast the actual or near collapse of so many household name financial institutions?
The second main risk is related. There is a reasonably broad (though by no means universal) consensus on the appropriate policy response to the emerging crisis. But for all of the justifiable talk of a ‘return to Keynes’ all crises have their peculiarities which means that policy makers are to some extent operating in the dark. There is an outside chance that the current policy stimulus is unable to prevent the global economy from experiencing a prolonged period of slow growth lasting well into the next decade. This would threaten the very basis of capitalism as we know it and trigger a profound social and political crisis in many countries.
The third main risk is again related. If global policy coordination isn’t seen to be doing the trick there will be political pressure in favour of economic nationalism. Globalisation would go into reverse and a new economic dark age would emerge. In the medium term this would place competing states or economic blocs in an effective state of war over scarce resources
Simon Hayes, Barclays Capital
Structural de-leveraging could overwhelm policymakers’ attempts to revive demand. Investors have lost confidence in the financial system’s ability to measure, monitor and manage credit risk. Businesses and households will have to function with a lower level of debt and some will not be economically viable in the new world. Businesses will fail, homes will be repossessed and optimism will be in short supply.
A leaden-footed response by the ECB to euro area weakness. While the Fed and the UK authorities appear alert to the risk of deflation, and prepared to act quickly and flexibly to counteract it, the ECB seems unconcerned. Some ECB hawks take the view that cutting rates below 2% for any period of time is unconscionable. But with activity contracting sharply both in the euro area and globally, and the euro at an all-time high, it is probably unwise to draw arbitrary lines in the sand for policy rates.
A widespread financing crisis in Emerging Europe. Several of the EU accession countries have large current account deficits and have borrowed heavily in foreign currency. They are extremely vulnerable to a cut-back in the availability of overseas financing. Crises in these countries would further depress the euro area’s trade prospects, and that would have repercussions for the UK.
Andrew Goodwin, Oxford Economics
Failure to end the freeze in bank lending; a sharp rise in unemployment above 3 million; more significant consumer retrenchment in reaction to significant damage to household balance sheets
It already looks like this recession will be at least as bad as - or quite possibly worse - than the early 1990s and the risks of a very severe recession are rising.
Martin Weale, National Institute of Economic and Social Research
There are essentially two risks. First of all that bank credit remains tight, with further large bankruptcies giving banks good reason to pare down their business. The second is that household saving may rise to normal levels of say 8-10% of income (as it needs to in the longer term) resulting in a very sharp fall of consumption.
Ian McCafferty, CBI employers’ organisation
An inability to restore credit flows. Until this happens, the economy will continue to be starved of oxygen, and the impact of both monetary and fiscal policies will remain constrained.
Further serious asset value erosion, either through malpractice (eg Medoff), or further sharp falls in capital markets. It would hit consumer confidence hard, further erode companies’ already beleaguered gearing ratios and damage further the prospects for pension and savings schemes.
Currency volatility and in particular a sharply weakening dollar. The dollar has rallied recently, in a flight to security, but the move to quantitative easing (which is likely to be larger than in Europe and Asia) undermines the longer term valuation of the dollar. A depreciating dollar would be mostly reflected in an appreciating euro, placing Europe under greater economic strain. A depreciating dollar would effectively allow the US to export some of its own recession onto the rest of the world.
How concerned should we be? It is likely that credit flows are restored only gradually, and that we see high levels of equity and currency volatility at sporadic intervals over the coming 12 months. If such episodes are sporadic, economic actors can probably absorb them without too much damage. But these things are ultimately cumulative, so it would be the coming together of such individual shocks that we should fear.
Malcolm Barr, JP Morgan
Risks in order:
1) How much consumption weakness with rising unemployment? We really do not know how severe the change in behaviour will be after 16 years in which a major labour shedding event has been avoided, and with consumption entering the downturn running unprecedentedly high relative to disposable incomes.
2) Can we get the banks lending again? Recapitalisation has only taken us part of the way, and policy as yet does not entirely coherent about what it is trying to achieve and how.
3) Sustaining confidence in the institutional framework (and sterling). The government is forecasting the largest deficit as a share of GDP on record, and the MPC may need to enter a collaborative phase with HMT on monetary policy if it gets to QE. Against the backdrop of a significant current a/c deficit, there is a risk that sterling asset markets may be undermined by a loss of confidence in the currency.
Michael Devereux, Centre for Business Taxation, Oxford University
1) That low or zero interest rates may actually worsen the problem of a lack of credit. If the current problem is not a lack of demand for funds by borrowers, but a lack of supply of funds by banks, then it is not clear how lower interest rates will help. It is even possible that it may exacerbate the problem.
2) A fiscal deficit which significantly exceeds even that predicted by the government. This would create longer-term problems of the size of debt, which in turn will fuel belief that the fiscal stimulus will be short-lived, which in turn will mean that the stimulus has a smaller effect.
Lena Komileva, Tullet Prebon
Protectionism is one of the biggest risk to the global economy in 2009. Following an extraordinary peak in global policy co-ordination following Lehman’s demise, the social costs of the economic crisis have directed political focus back to the national electorates. Unilateral, sector-focused strategies cannot replace internationally coherent and comprehensive policy measures, and can lead down the perilous path of protectionism that will amplify the social costs of this crisis.
Simon Rubinsohn, Royal Institution of Chartered Surveyors
A failure of the panoply of guarantees to encourage a greater level of lending, the entrenching of a deflationary mentality in consumer behaviour and a further wave of turmoil in financial markets as bond investors take fright of the need to absorb the massive increase in issuance.
Ray Barrell, National Institute of Economic and Social Research
More stupidity on the part of the regulators and governments. If another large bank is allowed to go, it might be hard to deal with. Failure to recapitalise the banks will also worsen any outlook we have. Some Europeans are talking about fiscal rectitude and contractionary fiscal expansions at present. This is nonsense and it shows they do not understand the situation. When there is credit rationing fiscal policy can be sued to remove the borrowing constraint, and as Samuelson’s le Chatelier principle suggests, removing a constraint improves the position. If they do not understand they should talk to Olivier Blanchard. Refusal to undertake coarse tuning is a mistake. I first misquoted St Augustine in a paper at the RES in 1993 (Solvency and Cycles – on our website) – we should say Lord make us solvent, but not yet. It is more apposite now than it was then.
John Van Reenen, Centre for Economic Performance, London School of Economics
1) We are in extremely uncertain territory and there are serious risks on the downside. For the first time in my lifetime a depression on the scale of the 1930s seems possible (although still not probable). People should be very concerned. The volatility of markets is at levels of the 1930s and there is lots of recent economic theory & evidence that this high uncertainty freezes economic action depressing GDP as the process of reallocating assets from less to more efficient activities slows down significantly.
2) The major risk not just to the recession but for longer term growth is inappropriate policy responses that will store up long term problems for the economy. Having the state taking on more and more of the equity of financial companies is a necessary evil (because of the huge contagion effects from the financial sector to the rest of the economy). But the likely bail-out of more and more non-financial firms is an unnecessary evil. Giving subsidies to the auto industry will make it harder to wean them off them in the future (bankruptcy is a much better alternative). It creates incentives for other countries to follow suit (as is happening in Canada, Germany and Sweden already). More and more other sectors will be following Detroit with the begging bowl. Excessive state intervention, the relaxing of competition policy and the risk of trade protectionism will stifle long-term growth.
3) More generally the crisis is generating a political contagion effect as public revulsion against financial markets spreads more generally to distrust of capitalism and markets. This is understandable , but more barriers to trade and unnecessary meddling in markets will certainly prolong the downturn. The lesson from the 1930s was that trade protection plus a weakening of competition policy help prolong the Great Depression. See my presentation on competition policy and the credit crunch.
(In the spirit of Keynes, here is a fourth risk when you asked for three). Germany needs to do more to boost demand in the eurozone by leading a serious fiscal stimulus. And this needs to be targeted at consumers not at producer subsidies (which is a problem with the French proposal).
Howard Davies, Director, London School of Economics and former MPC member
In the UK we clearly face an exchange rate risk. If Sterling continues to fall the authorities would have to react in some way. A second risk would be a further crisis of confidence in relation to a major British bank, which would place further pressure on the Government’s finances. A third risk might be a series of costly corporate collapses, with the Government coming under pressure to bail out large non-financial employers. These are all possible, if not probable risks – but enough to keep Ministers awake at night.
John Muellbauer, Oxford University
1) In Janine Aron and John, Muellbauer. 2008. “The Next Collapse: U.S. Price Inflation,” The Economists’ Voice and “US price deflation on the way.” Centre for Economic Policy Research, London we were among the first to forecast price deflation. At the time, we took an optimistic view on risks of a Japan-style lost deflationary decade or a Great Depression. In part this was based on the view that policy errors committed in Japan would not be repeated; in part on the structural differences between Japan and US, UK type economies. However, our policy optimism, though largely correct for the US, was overstated, perhaps even misguided for much of the rest of the world.
The central banks outside the US were far slower to wake up than I expected.
The extent of international co-ordination of monetary policy has been disappointing; and eurozone policy makers, monetary and fiscal, seem destined to be way ‘behind the curve’. I now fear a catastrophic year for the eurozone, dragging the UK with it, and risk of a eurozone deflation lasting several years. The failure of professional competence among eurozone economic advisers this year has been striking.
2) A second risk is of trade wars, or at least an increase in protectionism. My view for some months has been that growth in China in 2008Q4 and 2009Q1 will be negative on a quarter on quarter basis. The economy is far too geared to investment and exports, both of which are under enormous pressure. The China outlook for the rest of 2009 is not good either given that China’s Asian competitors have major currency depreciations and so gains in competitiveness relative to China. If China tries to depreciate its currency, hackles will rise in Washington, given China’s trade surplus with the US.
3) The third risk is of political instability in China if policy simply cannot compensate fast enough for its economic crisis.
Amit Kara, UBS
From a domestic perspective, the main risk on the downside is the extent of the credit squeeze. UK banks have a funding gap of around £700 billion. In the past that gap was filled in the interbank market and from securitisation. These channels are now closed. That closure will force banks to shrink balance sheets substantially over the next couple of years. If the adjustment towards a more sustainable level is weighted to the short term, 2009 could be a terrible year for the economy and a lot worse than the 1.8 per cent shrinkage in GDP growth that we envisage.
Other than that and at the global level, i would argue that trade barriers and failure of another large financial institution are key risks.
Peter Spencer, York University
It’s hard to know where to start, and certainly where to end! The banking system remains in a very shaky state. Private equity is vulnerable to credit and economic shocks and we have probably not seen the last of problems in the hedge fund sector. My big worry is however overseas investor confidence in government debt and sterling. Gilt yields have been depressed by the flight to quality and the prospect of zero interest rates. However this situation may not last. At the moment the Treasury is the only major UK borrower with any kind of credibility in international markets and it would be a disaster if it lost that status. People should be much more concerned about these risks.
Steve Machin, London School of Economics
1) Any more fallout in banking/finance.
2) Deflationary pressures.
3) Failure of any more interest rate cuts to boost consumption
Michael Saunders, Citi
Things could be worse from the vicious circle between falling output and deleveraging. Or if inflation expectations head sharply higher, hence constraining monetary policy. Or if the government makes foolish policy errors, such as emu entry or removing boe independence.
People should be worried. It will be a long journey back to economic stability.
Helene Rey, London Business School
One of the biggest risk is a 1930s style return to trade protectionism and in general lack of cooperation among nations in terms of economic policy. For example a coordinated fiscal stimulus within the euro area would be a lot better than ad hoc responses and some free riding behaviour by some countries. Another risk is full blown speculative attacks against the currencies of countries with the weakest external balance sheets.
Ian Plenderleith, former MPC member
Two risks I particularly worry about:
1) Serious slowdown in growth in China.
2) High-profile corporate failures in the UK. There are bound to be some more (retailers, airlines, providers of services we can do without) and the government can’t provide support in every case. But the bigger the failures, the wider the reverberations and the more damage done to confidence.
Willem Buiter, London School of Economics and former MPC member
1) A collapse of economic activity in key emerging markets, either precipitated by a sudden stop of gross capital inflows (Brazil, Russia, Turkey), by slowing export demand (China and everyone else) or domestic dislocations (China, India).
2) A triple financial crisis in the UK (banking sector, sterling, and sovereign debt).
3) A major financial crisis on the European continent, prompted by the unwillingness/inability of the ECB to engage in sufficient quantitative and qualitative easing because of concerns about the credit risk the ECB/Eurosystem would take on if it engaged in earnest in qualitative easing. The absence of clear fiscal backing for the ECB/Eurosystem, should the central bank suffer large capital losses through its monetary and liquidity enhancing market operations is a serious weakness of euro area institutional design. Who recapitalises the ECB?
I think there is a fifty-fifty chance that at least one of these contingencies materialises.
Gary Styles, Hometrack
1) The decline in sterling develops into a more widespread collapse in confidence in the UK
2) Business and consumer expectations remain stubbornly negative. All time record low interest rates and the fiscal injections are insufficient to restore confidence in consumers and businesses.
3) The banking sector fails to make available affordable funding lines for consumers and more importantly business during the recession
Alan Clarke, BNP Paribas
1) Policy measures fail. Interest rate cuts are either not passed on, or their effect is countered by even tighter rationing of credit, punitive arrangement fees, or loan to values that stifle first time buyers.
2) Forced selling. The housing market is already falling sharply. However, if surging unemployment leads to forced selling and repossessions like we saw in the early 90s, this will exacerbate falls in asset values and losses for banks.
3)Negative feedback loop. Whereby a worsening in the financial crisis aggravates the recession, which in turn worsens the financial crisis and so on…
Kevin Daly, Goldman Sachs
A major corporate failure would be damaging for confidence and there is a worrying lack of policy activism in some countries (though not the UK). However, I think the greatest risk is presented by what Donald Rumsfeld called “unknown unknowns”: developments that we have not conceived of yet and are therefore difficult to quantify.
Sushil Wadhwani, Wadhwani Asset Management and former MPC member
The three main risks are:
1) Monetary and fiscal stimulus may be too little/too late. E.g. some central banks may be slow to adopt “quantitative easing”
2) Deflation may take hold, further delaying the recovery of demand and fiscal policy measures may also be too little and/or too late. It is disappointing that there is resistance to a significant fiscal stimulus in some European countries.
3) The Chinese economy is slowing in a dramatic fashion. If EM demand continues to weaken, this could significantly lengthen the duration of this recession.
While these are major risks, it is heartening that some governments and central banks have, however, been willing to consider unconventional policies, for example, the expansion of the Federal Reserve balance sheet in the US. It is unlikely that policymakers will allow the situation to deteriorate as much as it did in Japan’s ”lost decade”, and the ”embedded deflation” experienced there does not seem the most likely scenario.
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