19 gennaio 2009

The Summer of last year witnessed a very sudden (and largely unexpected) deterioration in the economic climate. In July 2008, the biggest fear in Europe still seemed to be the possibility of accelerating inflation (after all, the European Central Bank raised its interest rate at the time). Only six months later Europe finds itself in a recession which could not only be severe and prolonged, but might even provoke deflation.

Events have unfolded with extraordinary speed. July and August saw sudden, sharp falls in commodity prices, in freight rates, and in incoming orders. September then witnessed the bankruptcy of Lehman Brothers, an event that triggered a wave of panic in subsequent months from which financial markets are only now beginning to (slowly) recover. Money markets and short-term credit extension virtually froze. The deleveraging process, which banks had been engaged in since the outbreak of the financial crisis, accelerated, making access to longer-term credit much more difficult. And partly in consequence, consumer and industrial confidence plummeted, stock markets and foreign trade flows collapsed the world over (including in countries which had until then seemed fairly immune to financial upheaval) and output has begun to decline.

After an initial period of hesitation, governments did react quite forcefully. To promote a resumption of inter-bank lending, they injected massive doses of liquidity. To prevent the credit crunch from getting worse, they provided large sums designed to help banks recapitalize their balance sheets. And to try and restore confidence, they sharply cut interest rates and guaranteed bank deposits. Finally, to sustain demand, they all embarked on more or less ambitious fiscal expansion programmes (particularly so in the case of the incoming Obama administration). It is too early to say whether these various measures will be sufficient to restore some degree of order in financial markets and some modicum of confidence in the real economy, but the authorities in both America and Europe are almost certainly ready to do more on both the monetary and fiscal fronts.

The short-term outlook for Europe’s economies is obviously very poor. A pronounced recession through 2009 is, by now, inevitable. The real uncertainty hinges on the extent and duration of this recession. Three possible scenarios can be envisaged:

1. A great depression, as in the 1930s;

2. A long stagnation, as in Japan in the 1990s;

3. A relatively brief but deep recession, deeper than those that Europe witnessed in the 1970s or in the early 1990s.

Though many commentators have drawn parallels between today’s experience and that of the Great Depression of the 1930s, a repeat of that episode is highly unlikely. Between 1929 and 1933, GDP declined by as much as 8 per cent per annum in the United States and by 1½ per cent per annum in Western Europe. This result owed much to the macroeconomic policies that were followed. In both Europe and America, banks were allowed to fail in large numbers, fiscal policy was designed to balance budgets (hence public expenditure was cut and taxes were raised just when the opposite policy would have been appropriate), and the world lurched into all-out protectionism. Today’s policy stance is clearly very, very different. The lessons of that time have been learned.

An alternative outcome could be the one that followed the bursting of an earlier huge financial bubble, the long stagnation from which Japan suffered in the 1990s (between 1991 and 1999, GDP grew by only 0.8 per cent per annum, and this in a country that had been used to growth rates of 4 to 5 per cent). Such an outcome is not implausible, since many of the causes of the present troubles are similar. What is different, however, is the policy response. The Japanese authorities dragged their feet in tackling the problems of their banks. On this occasion, Europe and America have acted much more swiftly.

The most likely outcome is that of a sharp recession, sharper than the ones that followed the oil shocks of the 1970s, or German unification in 1993. The closest parallel is probably with the Finnish and Swedish crises of 1991-93. These followed upon massive house price booms and led to major banking difficulties. The governments eventually introduced measures similar to those taken today, but Swedish GDP fell by nearly 3 per cent (and Finnish GDP by as much as 11 per cent, though special factors also played a role in that collapse). The outcome, on this occasion, could be more favourable because of a prompter policy response. On the other hand, the present recession could be equally, or even more, severe, as almost the whole world economy seems to be in similarly difficult conditions. Prospects are thus for possibly two years of negative growth with a hesitant recovery coming only in the second half of 2010.

GDP Growth Rates (%)

Andrea Boltho is now an Emeritus Fellow of Magdalen College, University of Oxford, where he was Fellow and Tutor in Economics from 1977. His areas of interest are international economics, economic policy and applied macroeconomics. In 1966 he began his career at the OECD’s Department of Economics, where was also editor of the publication Economic Outlook. In 1973-74 he spent a year as a researcher at the Economic Planning Agency in Tokyo.

He has been Visiting Professor at the Collège d’Europe in Bruges, at the Universities of Venice, Turin, Paris, Siena and Rome Tor Vergata, at the Bologna Center of the Johns Hopkins University, at the International University of Japan and at INSEAD. He served as a consultant to the World Bank, as a researcher for the Ente Einaudi and as a member of the Academic Board of the IFO Institute in Munich. He has collaborated with numerous multinational corporations such as ABB, FIAT, IBM, KPMG, Pirelli and Siemens.

He has written books on the Japanese and European economies, including an edited volume comparing Italy and Japan. After high school in Italy he studied at the London School of Economics and at the Universities of Paris and Oxford.He is a member of REAG’s European Advisory Board. His main task is to monitor and analyze macroeconomic trends in Europe and assist operating management in their business development activity.