What are the key problems facing the economy?
The immediate problem is a shortage of credit. Private saving in Britain has been low for many years and therefore the economy has been dependent on capital inflows from abroad. At the moment such funding is not forthcoming. Investors that have access to cash are unwilling to lend it because of fears over the solvency of potential borrowers, partly because the full extent of losses from housing and equity market declines is unclear, and partly because the prospect of a protracted recession raises the possibility that many borrowers will default on loans. The symptoms of recession, including weak consumer spending and rising unemployment, can be traced to a lack of demand arising from constraints on the availability of credit.
Is the government to blame for the predicament?
No. At base, the problems affecting the global economy result from a period of excessive lending that saw good money invested in bad projects that were never likely to deliver a return. The most famous example of this occurred in the US subprime mortgage market, and the fall out has been propagated internationally via globalized financial markets. The UK government could have pushed for stricter international regulation of lending ten years ago, but the government is not directly responsible for the predicament.
Whose policies, if any, are likely to be effective?
The steps taken by the government will stabilize the British banking system and lay the foundations for a return to positive economic growth in the medium-term. Many other countries, such as Germany and the USA, have also adopted fiscal stimulus approaches. The tax cuts and increases in spending are likely to be a useful injections of cash into an economic environment where many people are feeling worse off. Although the government has been criticised on the grounds that more spending will increase government debt, our national debt levels remain lower than many other G8 nations.
What’s the government’s plan for the crisis?
A fiscal stimulus. The government has agreed to take out loans using its own preferential credit lines and make the funds available to banks in the hope that banks will then pass on the money to consumers and businesses in the form of loans. There is also a much smaller package of tax cuts and government spending increases intended to boost incomes in the economy at a time when many face tight budgets.
What do the Conservatives propose?
The Conservative Party have advocated a National Loan Guarantee Scheme whereby the repayment of loans to businesses would be guaranteed in the event those businesses go bankrupt. The idea is that the scheme takes some of the risk out of lending and therefore induces banks to lend money to firms, who then feel confident to spend on hiring, investment and the like, which then supports expenditure and income in other parts of the economy.
Is there an end in sight?
The banks now have access to funds. What they require is profitable lending opportunities, but such opportunities are hard to come by at the moment. Most sectors are performing badly because demand is weak. Even when banks resume something approaching normal terms of lending there are lots of UK consumers with large debts to repay after a decade of rapid growth in borrowing, so demand will remain weak throughout 2009.