The measures taken in October were successful in preventing a systemic collapse and in the first week of the New Year there were some signs of a more general easing of pressures in financial markets. However there have been many relapses in the last 18 months and yesterday we again saw renewed fears in the markets. On the policy side, it is worth remembering that it is possible to overdo the degree of support. But at present the risks remain clearly to the down side. Therefore, in setting policy, the authorities both here and overseas need to consider whether further action on interest rates (or other monetary measures) or fiscal action is required. They need also to consider whether to do more to underpin the confidence among banks and among investors that is necessary to support the lending the economy needs to emerge from recession.
More generally, the uncertainty over the depth and duration of the recession discourages investment and puts cash flow at a premium. There is every incentive for companies to batten down the hatches. Unsurprisingly then, investment intentions have fallen sharply (Chart 6). The stock cycle is also depressing output. Stocks initially rise as sales falter and those stocks of inputs, work-in-progress and finished output that companies have become more difficult and expensive to finance. But running stocks down involves sharp cuts in production as we are seeing in the motor industry. All these forces develop in any recession. The special features of this one are its global reach, so the contraction at home is compounded by falling demand for exports, and the severity of the pressures on the banks many of whose survival has been at risk. They too face funding and capital pressures to shrink their balance sheets even if it means turning away good business. Successive credit surveys show not just a reduction in demand but a growing constraint on supply. Not only have spreads increased but there is clear evidence of quantity rationing in some markets which is compounding the normal contraction in investment and the squeeze on working capital. I should add that that does not mean that all banks have stopped lending. They have not.