2  Rygg, Nicolai (1950): Norges Bank i mellomkrigstiden (Norges Bank in the interwar years), Gyldendal Norske Forlag, p. 98. 3  Sejersted, Francis (1973): Ideal, teori og virkelighet. Nicolai Rygg og pengepolitikken i 1920-årene (Ideal, theory and reality. Nicolai Rygg and monetary policy in the 1920s) Cappelen, p. 51. BIS Review 131/2009  1  2  BIS Review 131/2009  Today we can see that the crisis was amplified by the surprise at how closely financial markets are interconnected. 4 Losses on high-risk US subprime mortgages triggered general distrust in the financial system. Financial institutions began to doubt their counterparties. They did not know whether counterparties held sufficient capital to cover any losses. Even worse, they were uncertain whether counterparties’ counterparties would be strong enough to withstand losses. So they stopped lending to each other. In the interwar period, as described by Rygg, depositors were responsible for the flight of funding. This time, that role was taken by banks’ lenders. Confidence had evaporated. Many banks worldwide had to take losses. The liquidity crisis turned into a solvency crisis. Banks in Norway have also noted that borrowers have experienced problems servicing their loans. However the increase in non-performing loans has been modest compared with the banking crisis at the beginning of the 1990s. 4  See for example Caballero, Ricardo J. and Pablo Kurlat (2009): “The ‘Surprising’ Origin and Nature of Financial Crises: A Macroeconomic Policy Proposal”. Paper presented at the Federal Reserve Bank of Kansas’ Jackson Hole Symposium.
Currently, the amount of spare capacity appears to be close to historical averages, which is not what we might expect when the economy is in such an early stage of recovery from recession. This, and other evidence, casts doubt on the degree of spare capacity in the economy and on how significant this factor will be in dampening inflation from its currently elevated level. 10  Business failures in the recent recession peaked at below 1% of firms, compared with 2.6% in the early 1990s and 1.8% in the early 1980s. 10  BIS Review 134/2010  Another puzzle is a surprising drop in productivity we have seen over the recession. Unusually, the decline in output appears to have been much bigger than the decline in employment when normally we observe the opposite result. In terms of the impact on unemployment, this has been a good thing, helping to dampen the cost of the recession in terms of lost jobs. But this raises further questions about how much slack there is in the UK labour market as the economy begins to grow and generate new jobs. The behaviour of productivity in the recession also raises the question of whether the UK productivity growth trend over the medium term has shifted. If it has, we may make big mistakes basing our assessment of underlying growth on past productivity trends.