reassemble. House builders have seen their share prices fall dramatically
and some have gone under. And because Britain’s planning system links new social housing to new private housing, the supply
of social housing has been dragged down too.
Then the emergence of bad debt among home buyers in a falling market has had knock-on effects on the banks that have lent
the money. Banks with a large mortgage portfolio, like Northern Rock, Bradford & Bingley and Alliance & Leicester, had to
acknowledge the risk of large and growing losses on their mortgage books, added to the losses from other market activities.
Banks responded in time-honoured fashion: by cracking down hard on those to whom they had been only too keen to lend in happier
times. Then, in September 2008, the generalized collapse of confidence in banks led to the virtual disappearance of the traditional
specialist mortgage lenders. The share price of Bradford & Bingley collapsed and the bank was promptly nationalized in order
to prevent a Northern Rock-style saga. Halifax–Bank of Scotland (HBOS) was absorbed by Lloyds in order to prevent its collapsing
in turn, before both had to be saved and recapitalized by the government, as was the Royal Bank of Scotland / NatWest. By
this stage we wereno longer dealing with a British housing and banking problem but with a global financial crisis, and I return to that bigger
story in the next chapter.
The combined effect of the credit crunch, the deteriorating housing market, and the squeeze on living standards from the earlier
hike in energy and food prices created the conditions for a recession. At the end of 2008 recession psychology was taking
over rapidly. Consumers had become very anxious. They were reluctant to spend. Retail sales were falling sharply. And this
in turn led to a slowdown in production, workers were being laid off, more people were unable to sustain mortgage and other
debt payments, and pessimism was deepening in a vicious circle. At some point producers or consumers or both will recover
their nerve and start to spend and invest, but that generalized confidence had not returned by the autumn of 2009, although
the sense of crisis and panic had passed. One of the central premises of post-war Keynesian economics has been that government
policy measures should be used to stimulate demand during a recession. And the shared understanding from previous financial
crises, notably that of the 1930s, has been that such intervention has to be decisive and rapid. These insights have informed
policy in the UK, and elsewhere, throughout this crisis and have undoubtedly had an impact.
The obvious first step was to cut interest rates. It is common ground among both monetarists and Keynesians that this is the
first and quickest way to stimulate demand. One problem has been that the government has transferred the power to set interest
rates to the Bank of England, which has an explicit mandate to use interest rates to curb consumer price inflation, which
at the height of the crisis was running well above the official target level of 2 per cent. The Bank of England was initially
torn between its commitment to combat inflation and a wish to stimulate the economy with interest rate cuts. There was no
easy answer to this dilemma. Faced with precisely the same problem, the eurozoneauthorities initially opted to raise rates and the USA to cut them, because they assessed the balance of risks in different
ways. But by October 2008 it had become clear that the British banking system was caught up in a global financial crisis of
massive and dangerous proportions. One of the few remedies open to the authorities in order to prevent a slump was a big cut
in the interest rate. For those of us who believed in the principle of operational independence for the Bank of England there
was a dilemma: to defer to the Bank, which seemed to be moving too slowly, or to call publicly for a
and some have gone under. And because Britain’s planning system links new social housing to new private housing, the supply
of social housing has been dragged down too.
Then the emergence of bad debt among home buyers in a falling market has had knock-on effects on the banks that have lent
the money. Banks with a large mortgage portfolio, like Northern Rock, Bradford & Bingley and Alliance & Leicester, had to
acknowledge the risk of large and growing losses on their mortgage books, added to the losses from other market activities.
Banks responded in time-honoured fashion: by cracking down hard on those to whom they had been only too keen to lend in happier
times. Then, in September 2008, the generalized collapse of confidence in banks led to the virtual disappearance of the traditional
specialist mortgage lenders. The share price of Bradford & Bingley collapsed and the bank was promptly nationalized in order
to prevent a Northern Rock-style saga. Halifax–Bank of Scotland (HBOS) was absorbed by Lloyds in order to prevent its collapsing
in turn, before both had to be saved and recapitalized by the government, as was the Royal Bank of Scotland / NatWest. By
this stage we wereno longer dealing with a British housing and banking problem but with a global financial crisis, and I return to that bigger
story in the next chapter.
The combined effect of the credit crunch, the deteriorating housing market, and the squeeze on living standards from the earlier
hike in energy and food prices created the conditions for a recession. At the end of 2008 recession psychology was taking
over rapidly. Consumers had become very anxious. They were reluctant to spend. Retail sales were falling sharply. And this
in turn led to a slowdown in production, workers were being laid off, more people were unable to sustain mortgage and other
debt payments, and pessimism was deepening in a vicious circle. At some point producers or consumers or both will recover
their nerve and start to spend and invest, but that generalized confidence had not returned by the autumn of 2009, although
the sense of crisis and panic had passed. One of the central premises of post-war Keynesian economics has been that government
policy measures should be used to stimulate demand during a recession. And the shared understanding from previous financial
crises, notably that of the 1930s, has been that such intervention has to be decisive and rapid. These insights have informed
policy in the UK, and elsewhere, throughout this crisis and have undoubtedly had an impact.
The obvious first step was to cut interest rates. It is common ground among both monetarists and Keynesians that this is the
first and quickest way to stimulate demand. One problem has been that the government has transferred the power to set interest
rates to the Bank of England, which has an explicit mandate to use interest rates to curb consumer price inflation, which
at the height of the crisis was running well above the official target level of 2 per cent. The Bank of England was initially
torn between its commitment to combat inflation and a wish to stimulate the economy with interest rate cuts. There was no
easy answer to this dilemma. Faced with precisely the same problem, the eurozoneauthorities initially opted to raise rates and the USA to cut them, because they assessed the balance of risks in different
ways. But by October 2008 it had become clear that the British banking system was caught up in a global financial crisis of
massive and dangerous proportions. One of the few remedies open to the authorities in order to prevent a slump was a big cut
in the interest rate. For those of us who believed in the principle of operational independence for the Bank of England there
was a dilemma: to defer to the Bank, which seemed to be moving too slowly, or to call publicly for a
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