>GLOBAL ECONOMICS (HSBC)

And when the money runs out?

• The fiscal lifeboats launched to support the global economy…
• …have, for some, left the budgetary outlook in a total mess
• Austerity is the best we can hope for…the alternatives include currency crisis, inflationary dangers and rising default risk

Three strategies to cope with the threat of depression

Three broad strategies have so far been used by policymakers to deal with the credit crunch and
global recession.

■ Capital has been injected into banks to stop them from becoming insolvent. The aim has
been to prevent a repeat of the multiple bank failures of the 1930s which played such an
important role in turning a recession into a depression.

■ As interest rates have approached zero, and bank lending remains constrained, some central banks have pursued so-called “quantitative easing” policies, designed to lower a broader spectrum of interest rates (including those on longer-dated government bonds and corporate bonds) and/or to increase the supply of money in the economy. Quantitative easing arguably is designed to pump credit into the economy by bypassing the banking system altogether.

■ Fiscal easing has become a key part of the story. As private demand has wilted in the light of falls in housing and stock-market wealth, excessive debt levels and the credit crunch, so the public sector has stepped in to shore up overall demand. Tax cuts and public spending increases have become key policy tools in the attempt to prevent a Great Depression mark II. Debts previously held in the private sector are now increasingly being held in the public sector. In the process, John Maynard Keynes has seen a remarkably rapid rehabilitation.

All three of these strategies carry fiscal implications. Capital injections involve government ownership of banks and the banks’ former assets. Although banking assets are hopefully bought cheaply, there is nevertheless a risk for future tax payers if, for example, the assets fall further in value (the converse equally applies: should the assets rise in value, any subsequent realised capital gain can be used to pay down public debt and, hence, relieve the burden on future tax payers). Quantitative easing shackles the central bank to the government in ways unimaginable a handful of years ago. The Bank of England, for example, is now buying gilts. If its actions place a ceiling on gilt yields, might that encourage the government to borrow more? Or might, instead, purchases of corporate bonds and asset-backed securities be funded not by printing money but, instead, by issuing shortdated government paper, thereby increasing government borrowing at the short-end and distorting the slope of the yield curve?


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