Chaper and yet cheaper...

The base rate was lowered yet again by the MPC, to its lowest since the Bank was set up in 1694. This says something about the predicament produced under the stewardship of G. Brown, though not his fault, of course. Never before in recessions, depressions, war times when the nation was threatened has the rate been set so low.

The reason is two fold, and both relate to time.

Firstly, the government has taken steps to restore the liquidity of the banks because we have not saved enough to produce healthy balances by our deposits, and banks cannot borrow sufficient funds elsewhere. Still, according to owners of small businesses, banks are not lending sufficiently.

The reason for this is the sheer uncertainty that lenders face - they do not lend to each other because they are fearful of what may turn up in future balance sheets of other banks. On top of this is the strong possibility that borrowers from the banks, - the small firms principally, may themselves go bust in the recession and cause similar problems for the banks.

In time, and this is where it comes in, lender balance sheets may improve, if the government does not demand such quick payment of monies it has lent to banks, or by some other means. Then confidence will have returned. This will take too long, of course, so the government was precipitate action now, or even earlier.

The problem is that the government thinks that it can pull levers, and like so many machines borrowers and lenders will act precisely as the government decrees. They are dealing with people, not machines, and people are subject to mood, doubt, fear, and so on.

This is why the Cameron proposal, for the government to "guarantee" for a fee all the debts of those who borrow from the banks. This should make the banks more keen to lend with confidence. Cameron should go further and try to reduce the uncertainty and suspicion between banks in the wholesale market. This could require compulsory auditing, with certification, that there are no more "poisonous" assets being hidden off balance sheet. There would have to be heavy fines on bank officials who are after certification are found to be deceiving. Perhaps full disclosure should be required between all participants who wish to engage in the money market.

The first difficulty, of a lack of confidence, should be tackled by the government, rather than dressing down the banks in public and threatening them with a megaphone.

The second time problem is the uncertainty about how long any measure will take to have an affect. (The confidence issue is an example of this also.) Whether the government tries to drag forward infrastructure projects, where it could be years before the project is complete and the full employment and income gains realised, or whether the government decides by some means to create money by enlarging the safe asset bases of banks so that they are happy to lend more, in both cases, and others, there is uncertainty about the time when sufficient extra spending has been undertaken.

A major problem is that although the government may succeed in causing new expenditure, some of it may arrive too late to help, indeed it may be trying to raise expenditure in some areas which are already fully recovered with the result that inflation could become real possibility through shortages and bottlenecks. This last could be reinforced if sterling loses more value and causes import prices to rise.

Someone has said that trying to manipulate the economy in a fine and detailed way is like steering a ship by looking at the wake, that is that the decision makers will always be acting on information which is out of date. We are still revising the output figures for the April-June quarter 2008, and company and trade data may be even longer out of date.

There is a further difficulty, especially when the government does not decide on the direction of spending but merely inflates the bubble of debt still further. Once the initial money leaves the government's hands, short of repressive controls it cannot forecast in what further directions it will be spent. This is the uncertainty of what income recipients may do. The government seriously miscalculated in its hopes over the VAT reduction. It seems that it did not consider the possibility that consumers might save the small amount they saved in order to reduce their over-large debts. This could happen again, or they could decide to spend new income on finest french wines or imported electronic goods, which will not produce much further income here.

The government, to its credit, has recognised that extra income here could well be spent to produce foreign goods and services, which will aid recovery abroad and not here. This is why our wizard debt maker, G. Brown, has been appealing for international cooperation, to encourage foreigners to reciprocate by buying our goods and services and not just their own.

Unfortunately some of our major foreign currency earners have been damaged already by the recession, e.g. London financial expertise, and others may yet be, - such as Wedgewood, Jaguar, etc. It may be that our economy will have suffered longer and deeper damage to its productive capacity than is the case in other countries where the recession was less severe.