Sean O’Grady: More quantitative easing could hold the key to economic recovery

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The Independent Online

Which should have been the most significant news event of last week, at least as far as Gordon Brown's future is concerned? The political or the economic news? From Friday lunchtime onwards, most of the news bulletins put the result of the disastrous Norwich by-election ahead of the rather more shocking second-quarter GDP figures. "Brown suffers poll wipeout" was a typical headline. Yet it was no surprise, and that is why it didn't matter that much.

It was merely a confirmation of what we all knew. The GDP figures – a shrinkage of 0.8 per cent – frightened everyone because they were way worse than anyone thought they would be.

They ought to have been the bigger story. Maybe they weren't because everyone understands a win/lose election; the subtle calibrations of economics need a little more effort to comprehend. What is happening to the economy is disturbing, for ministers as well as the rest of us; the fact that GDP contracted again between April and June matters, politically as well as economically.

The reasons are fairly easy to see. The further the economy falls, the harder it will be to get back to the peak of output seen in the first months of 2008. Already we have gone so far backwards that the slump in output from the peak five quarters ago now exceeds that endured in the early 1980s recession – a downturn the like of which the nation could have been forgiven for thinking it would never have to go through again. Our newly competitive market economy, the reward for the pain we went through in the 1980s, was supposed to protect us from such vicissitudes. It seems not, and, contrary to what politicians of both parties have claimed over the decades about the British "economic miracle" and the end of "boom and bust", it has left us no more immune to the economic cycle than to swine flu.

The point here is that it is touch-and-go as to whether the UK economy by next spring will be much larger, if at all, than it was when Labour was re-elected in 2005, but it certainly will be markedly smaller than when Gordon Brown moved into Number 10 in June 2007. No prime minister since the Second World War, and maybe as far back as Ramsay MacDonald in 1931, has had to face the electorate with such a poor record on economic growth as Mr Brown's.

He has a perfectly good case to make that the policies he and the Governor of the Bank of England, Mervyn King, adopted to save the banking system and boost the economy through quantitative easing were better judged than the Opposition's temporisings.

But the Government's arguments are weakened by the bald facts on growth, which easily chime with popular feeling: most citizens feel poorer, as the value of their homes has been savagely devalued, they see no chance of a pay rise, and they are threatened with tax hikes.

A significant minority face ruin as a result of unemployment. That is what a fall in GDP means in harsh, human terms. And yet, for all that, we must remember that the GDP figures are essentially historical, and the worst of the downturn is behind us.

Buried by the Norwich by-election and that grim GDP data at the end of the week were the results of the latest Bank of England Agents' Survey – qualitative evidence about the state of the economy gathered over the last few weeks by the Bank's representatives across 12 UK regions. It isn't scientific, but it is social scientific. The trends are denominated in agents' "scores" from talking to a wide variety of companies, rather than in hard numbers with a £ or % sign attached.

This more timely evidence suggests that in many areas things are ameliorating. To summarise, here is the good news: consumer spending has started to stabilise; the recovery in the housing market has continued; the "inventory recession" (destocking to adjust to lower demand) is pretty much done; many firms say that they have now completed the bulk of their sackings.

But, the bad news is the same as ever. The fundamental economic fact of the last two years remains: the banks are broken and the credit crunch continues. It has morphed into a more selective version compared to the blanket panics of 2008, but the cost and availability of credit is a problem. More than ever, banks love to lend to people who don't need the money, and loath forwarding credit to those who in fact need it most.

Alistair Darling wants to know why the cost of borrowing is high when interest rates are so low. Moneyfacts have told us about the consumer credit and mortgage markets; the Bank's agents say the same about finance for business. They report: "Availability of credit remained a key concern ... Some felt that banks' appetite for lending had increased, and a number of larger firms had been able to make successful rights issues. But many others had continued to encounter difficulties in securing finance." They say fees and charges are rising.

So what are the chances that the Chancellor will get his way? Slim. In the first place, as he himself recognises, the banks desperately need to rebuild their margins, profitability and capital so that they no longer have to depend upon the state and can eventually return to the private sector. That means maxing out on good quality, high-fee, lucrative lending to rock-solid credit prospects, and leaving tottering small businesses to go to the wall. In any case, it has to be said, a good number of those firms need equity rather than more debt to survive – a point of sophistication stressed by insolvency practitioners but few others. Even the latest figures from the British Bankers Association show that lending to business is barely higher than in 2008, in the depths of the crisis.

Mr Darling's second problem is that the semi-nationalised banks' commitments to lend an apparent extra £90bn this year is couched in all sorts of rubbery conditions, where they have been made public. Obviously Mr Darling knows full well what they're supposed to do, and what the spirit of the lending agreements is. But even this shrewd Edinburgh lawyer may not be able to pin the banks down. For every hard luck case he can point to, they can claim that the business in question just wasn't sound enough to risk shareholders' (i.e. taxpayers') funds. Stalemate.

All of which suggests that the only way through this paradox – the one that says that what's good for the banks is bad for the economy as a whole – may be for the Bank of England to push more money into the economy and extend quantitative easing. The Chancellor would be happy to oblige by giving them permission to buy more of his gilts. After all, we could be 10 months away from a general election...

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