Policy Responses to the Next Recession
Worrying about the ‘next recession’ when we still haven’t fully recovered from the last one seems like an especially depressing way to spend one’s time. But over the last few days, ever since Mark Carney’s press conference on Wednesday, it’s something that has been bothering me.
To take the obvious point first – we still have a long way to go to make up the ground lost in 2008/09. GDP remains 1.3% below its 2008 peak and whist the labour market data has been better in recent months, unemployment is still elevated at 7.1%. On current trends GDP will be back at its Q1 2008 peak by this summer although still well below the pre-recession trend.
Given all of this – it is surely too early to be worrying about the next downturn.
Whilst Mark Carney may have acknowledged that recovery is not yet balanced or sustainable (it being driven by a falling household savings ratio and consumer spending) he did not say it was about to stop. Instead he presented some of the strongest Bank of England forecasts of recent times – above trend growth of 3.4% in 2014 and strong growth in the following two years.
The outlook (in terms of headline growth) looks stronger at the moment than at any time since 2008 but eventually it will end. Of course no one knows how long it will be until we hit that eventuality. Maybe we are in the midst of another 1992-2007 style boom, and the recovery that began in late 2009 will run until the mid 2020s. We have to hope that is the case, but also remember that during the ‘Great Moderation’ central bankers and politicians became complacent (‘no more boom and bust’ comes to mind).
More typically in the late twentieth century the average UK business cycle was around 5.7 years, in the early 20th century and throughout the nineteenth it was around 8-8.5 years. At some point in the late 2010s it seems likely we will experience a downturn.
And this is what is worrying me, because the question that keeps coming back to me is: what is the policy response to a recession if rates already very low and government/debt to GDP already high?
Mark Carney was very clear last week that interest rates will remain at 0.5% for some time yet and then only rise gradually.
Any down-turn in the late 2010s that began with interest rates still low would mean (by definition) that there was less room to cut rates than in previous recessions. In the current downturn rates were slashed from 5.5% at the start of the downturn (and from 5.75% months before) to just 0.5%. Between 1990 and 1993, base rate fell from almost 14% to under 6%. In the 1980s downturn rates were cut from 17% in late 1979 to around 10% by late 1983.
Fiscal policy may also be perceived as restrained in any late 2010s recession. On the current OBR forecasts public sector debt to GDP will be around 75% in 2018/19.
Government/debt to GDP at 75% would not rule out any form of fiscal stimulus in economic terms but it would make the political case for such a stimulus much harder to make. It is of course easier to argue for a stimulus that will increase debt in the short run if the existing debt stock is lower.
Similarly, even with rates on the floor there is much that could be done in terms of monetary stimulus – more QE, more Funding for lending type interventions in the credit markets. But again I think the political case for such interventions would be trickier than in 2008/09.
Policy makers usually prefer to talk of avoiding a recession rather than the exact policy actions they would take if one occurred but if we learned anything from 1992-2007 it was that the business cycle hasn’t gone away and it is best to think through these sorts of things before they happen.