The failure of households to build up savings during the economic downturn is hampering prospects fo...
The failure of households to build up savings during the economic downturn is hampering prospects for recovery, according to brokers Smithers & Co.
Chairman Andrew Smithers said recessions since WWII have typically been caused by central banks raising interest rates in response to inflationary pressures.
Households generally respond by increasing their savings and the resultant decline in consumption then led to falls in investment. Once the threat of inflation receded, central banks cut interest rates and the the economy recovered as savings fell.
But Smithers said the recent downturn was driven by excessive investment in the US, financed by a foreign savings surplus and prolonged by a decline in accounting standards.
'As savings were never boosted, the normal process of recovery, which depends on falling savings, is not available,' he said.
'The massive rise in debt in both the household and corporate sectors, which accompanied the asset bubble, has also reduced the ability of lower interest rates to stimulate demand.' Smithers said the policy response has so far been insufficient to counter the negative impact of the lack of savings and further fiscal stimulus is required to kick-start growth.
'If lower interest rates will not boost consumption, then either fiscal policy must be eased, or monetary policy must be extreme enough to raise investment,' he said.
Although he conceded increased budget deficits are not a long-term solution, they could still be used to achieve cyclical recovery. However the current political unpopularity of overly large deficits seems to make this unlikely.
Therefore monetary policy will need to be strong enough to boost investment and get cyclical recovery underway.
'The most probable result is a period of disappointment and economic weakness, during which doubts about the efficacy of monetary policy will become much aired and add to the nervousness of markets. This will probably be followed by additional monetary stimulus which should ultimately lead to recovery.'
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