A recession no-one has ever seen before
For the generation of businessmen who have never known a recession it may seem academic that this one is so different from others. But it matters for those hoping to use past experience to cope with this downturn.
Normally, recessions are associated with high inflation and high interest rates. This time those two rates are so low they could become zero. It requires a completely different reaction from business.
It barely matters whether rising prices and expensive money caused past recessions but the government response was to increase interest rates to curb inflation, to support a currency undermined by the recession and to finance the state’s budget deficit. The result was usually to make the recession worse and to exacerbate short-term inflation as wages and prices rose sought to compensate for the cost.
A recession in which interest rates are slashed is a new phenomenon. Consumers and companies may find their debt a burden but it is because of lower income, not because of the higher cost. Indeed, finance costs ought to be falling and thus relieving pressure on households and profit margins.
Similarly, the fall in inflation is easing the financial pressures on consumers and business costs. That is better than an increase in costs but low interest and inflation rates bring their own problems.
The same low inflation that keeps costs down prevents companies raising their selling prices and limits – even eliminates – pay increases.
An economy without inflation is in danger of being an economy without growth, as Japan demonstrated throughout the 1990s. That is why the government’s target is for 2 per cent inflation rather than zero price rises. The best way to keep price rises above target is for the recession to ease – and the best way to achieve that might be low interest rates.
The difficulty in escaping the circle of low inflation and low interest rates is likely to be as hard as escaping from the spiral of high rates we had in previous recessions, but this time we are in uncharted country. The lessons from the past are of little value.
January 13th, 2009 at 5:59 am
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