Yesterday I heard different senior economists give their views of the Credit Crunch and recession and what we could do to get out of it. They gave them under Chatham House rules, so I will call them Views 1, 2 ,3 and 4, grouping opinions into the four main different positions at the meeting.
View 1 expressed worry about extremes in policy making. Whilst they could live with a modest reflationary package, they are concerned about undue borrowing or money printing, and felt there could be an inflation problem in due course. They also believed that we had to accept a substantial one off drop in national output, reflecting the activity of banks and shadow banks that had gone over the top and could not be continued. They felt that the recession had to take its course, and that policy action of any extreme kind could cause inflation, or fail to stabilise the asset markets.
View 2 argued that individuals and companies are very short of money. Money supply has ground to an abrupt halt in recent months. They therefore favoured the UK government borrowing substantial sums from the Bank of England or the commercial banks, to spend or give away as tax reductions so the private sector has more money to spend and repay debt. They did not agree with the recapitalisation and felt the banks had sufficient capital.
View 3 argued that the government had been right to put more money into the banks and might have to do some more. They also felt some money printing may be necessary in current circumstances and agreed there could be a period of underfunding of the borrowing requirement for a bit to generate some more money in private hands. They felt house prices should fall another 25%, preferably quickly, so the market could then be stabilised. They favoured a Medium Term fiscal strategy to start to reduce the large deficits and reassure markets that in due course Prudence would return.
View 4 argued that banks had to go back to simple banking models, relying on deposits from customers as sources of funds and lending to customers as assets. They were pessimistic about how to pull the economy out of recession, and ageed house prices had to fall further.
From the discussion which ensued, the following points emerged which I think are correct:
We will lose a portion of our National Output, represented by banking and related financial activities on bloated balance sheets, which will no longer be possible in current conditions. The UK will take a large hit as we have large banks and hedge funds relative to our GNP, and our growth was flattered by the huge financial service expansion in London over the last decade.
Somehow the balance sheets of companies and individuals have to be strengthened, which means they do need more cash and income, at the same time as we need more demand from their spending.
Some of the extra demand will come from public spending, with tax cuts and benefit payments giving individuals more money to spend
Creating more deposit money in the banks by underfunding or by the government borrowing from the Bank of England is worth a try. The US authorities have expanded the Fed’s balance sheet and are discussing buying up Treasury bonds.
Increasing future public spending on large infrastructure projects takes too long for the decision to be translated into jobs and spending. Income Tax cuts provide the fastest way of injecting the borrowed public money into the cash starved private sector.
The government does need to construct a budget plan on spending that will start to control borrowing and outlays.
It should remove its VAT cut, and substitute cheaper Income tax reductions.
The government needs to cut its risk of losses in the nationalised banks by cost reductions, netting off futures and options positions and reducing its risk to Investment bank type activities.
The government, now it is a bank owner, is the best placed to carry out the traditional banking utility function, making its direct contribution to a reduction in Investment banking capacity to reflect the new circumstances.