David Blanchflower: The new lending schemes are good but not enough

The Greek crisis has spread to Spain; Italy has moved into the crosshairs along with Cyprus

There are growing signs of panic among the UK's top economic policymakers who are now seriously behind the curve. The possibility of something cataclysmic happening in the euro area is rising by the day. Some of us have been warning for a while that the chances of a devastatingly bad outcome has been rising these many months.

The Greek crisis has spread to Spain, where money is now being withdrawn apace from bank accounts. The Spanish bailout brought relief for a few hours and bond yields then started to rise again. Italy has now moved into the crosshairs, along with little Cyprus, and with France sitting in the background. The markets remain in turmoil awaiting the outcome of the Greek elections over the weekend.

This is what happens when events get away from you. At the beginning of May the "too little, too late" dithering MPC produced a forecast that showed that under existing policies inflation would undershoot the target, which meant they should have put more stimulus into the economy. They produced no convincing explanation for their inaction; the only conclusion I drew was of dithering incompetence.

They even went as far as to warn that there were major risks to the downside from the eurozone, but concluded that risks to inflation were balanced. Of course that was laughable nonsense, as was made clear by the International Monetary Fund a few days later when they pointed out that risks to the UK economy were to the downside and urged the MPC to inject more stimulus.

So a panic-stricken Sir Mervyn King in his Mansion House speech claimed that "the other effect of the euro-area crisis has been to create a large black cloud of uncertainty hanging over not only the euro area but our economy too, and indeed the world economy as a whole … The black cloud has dampened animal spirits so that businesses and households are battening down the hatches to prepare for the storms ahead. The result is that lower spending leads to lower incomes and a self-reinforcing weaker picture for growth."

It's unclear why this black cloud is any different today than it was at the beginning of May when the MPC failed to act, or in April or March for that matter, when it was plain as a pikestaff. Maybe King just spotted that what he has been saying was hopelessly wrong. On 16 May he argued that "the bigger picture is of a gradual recovery in output". No; it wasn't then and it isn't now. The animal spirits of consumer and business confidence started collapsing in the spring of 2010. So what took King so long to notice? This really isn't good enough; the scale of the risks may be hard to quantify but we know their direction with 100 per cent certainty: down.

In his Mansion House speech our part-time Chancellor, who increasingly looks out of his depth as the polls slide, continued to repeat his ridiculous economic gibberish on the way to proceed. "Theory and evidence suggest that tight fiscal policy and loose monetary policy is the right macroeconomic mix to help rebalance an economy."

The evidence from 2008 is that the only thing that works is loose monetary policy combined with loose fiscal policy. There is no such thing as an expansionary fiscal contraction, as the last six quarters of negative growth have shown us so clearly. There has been no rebalancing of the economy, only collapse. Time for a change, George mate.

The £80bn funding for lending programme that the Treasury and the Bank of England jointly announced last week marks the first time banks will have been provided with cheap long-term funding which can be obtained with lower quality collateral than in the past. The idea is to address the increased costs of loans and mortgages and works by allowing British banks to pledge their illiquid loans for highly liquid government bonds they can then sell. This is a major U-turn for Mervyn King, who had made clear his opposition to such measures on a number of earlier occasions. His change of heart presumably has to do with the fact that the fiscal and monetary plans he backed haven't delivered.

The success of the programme is conditional on banks increasing their lending to non-financial institutions whose borrowing is down around £90bn since the crisis started in 2008. The Bank of England will impose significant haircuts and the Government will indemnify the Bank's balance sheet from any losses, which puts the taxpayer at some risk. The concern is that it won't boost lending because demand is so weak. Even with cheap money, firms won't start investing as the economic prospects are so uncertain and the consumer has been scared away. The Bank also intends to throw further money at the problem by holding an Extended Collateral Term Repo Facility (ECTR) auction at least monthly until further notice.

The difficulties the economy faces were put even further into focus by the awful trade figures which showed that the overall goods and services deficit expanded significantly in April, rising to £4.4bn compared with £3bn in March. The deficit in goods in April widened from £8.7bn to £10.1bn, its highest level in seven months. Added to that was more bad news on the construction output front, which showed a 13.3 per cent month-on-month and 8.5 per cent year-on-year drop. These data add to growing fears that the GDP data for Q22012 will also be negative. Recession deniers, where you now?

These new lending programmes are welcome, but they are not enough. In all likelihood the Federal Reserve will act next week to pump in more stimulus as the data suggests that the US economy has started to slow. Now is the time for the Monetary Policy Committee to act to provide massive additional quantitative easing of at least an additional £100bn at its July meeting, if not before. Next week could be make or break for the world economy.

Comments