Vicky Pryce: There Is An EU Policy Paralysis
As the markets in London went into another downturn on Friday afternoon, HuffPost UK caught up with Vicky Pryce, former Joint Head of the UK Government Economic Service. What's her assessment of the financial turmoil - and how will it affect Britain?
Can we see parallels between today's volatility and the credit crunch of 2007 and/or the financial crisis of 2008?
The parallel we can look at is whether there is going to be a loss of trust between the banks. We might end up with a credit crunch if what happens now reduces the value of the banks' balance sheets - in particular government debt - then those banks are going to be difficulty. Although they have liquidity now to withstand some of it, we could now be talking about banks going bankrupt pretty quickly. If a bank in the UK is dealing with an Italian bank which is holding a lot of Italian government debt, they might want to stop dealing with it and that would stop the credit flow. So if you stop trusting any of the other banks you're dealing with, that means they can't raise money in the wholesale markets and thus won't be able to lend money to businesses and consumers.
The second parallel is that we're talking about economies that are now contracting again - in Europe that's Greece, Portugal, possibly Ireland, possibly Spain. Or at least if they're not declining they're not growing. That means they will have to introduce even more austerity measures. These are worst case scenarios.
So if not the worst-case scenario, what's the more likely one?
The more likely scenario is that the policy makers will realise they have to do something about it and have a united front. The problem at the moment is that they're not agreeing on things, each blaming each other for why nothing is going on. If they start talking with a unified voice and the ECB steps in, buying bonds in Italy and France, then that should calm the market.
There have been the changes to the European Stabilisation Fund, agreed to allow direct intervention in countries which weren't yet in a bailout or default situation, but which looked under pressure. Everyone thought it was a brilliant idea, but since then nothing has happened in Europe. It takes time, and Barosso has been screaming about it, saying there is contagion going on. That needs to be done very fast, and the ECB needs to step in, in the short term, to play the role that Fund will ultimately take on. The problem is a policy paralysis.
Is Italy really in big trouble?
The problem Italy has is not its deficit, it's the debt. That's why they're now talking about austerity measures there. What Italy really needs is faster growth and for it to be more competitive. Italy imports too much and did this because of the balance of payments constraints being removed when it joined the Euro. Now the crisis has hit and Italy can't reduce interest rates and there is no real lender of last resort.
So why are the markets reacting in this way?
In an environment like this, the markets look at it and say, 'Aah , we're going to test it.' We're going to punish them, if you like. They have been testing the willingness of policymakers to step in. I'm sure Barroso's comments didn't help the markets but I can see why he said what he did. The various countries, particularly Germany and France, were not prepared to get their act together to help Greece early enough. The ECB governor's comments are believed to have spooked the markets, and he was of course blaming the member states, urging them to get their act together on structural reform, but of course that takes ages.
The markets in London recovered briefly on Friday after the better than expected US jobs figures, but have been sliding since then. Why is that?
If you look at the US in particular the employment figures were not bad, but if you look at prospects for growth there, the risks are still there. The prospects for the US are low, the prospects for Europe are low. The emerging markets are slowing down, China is putting on the brakes to slow inflation. You have a global environment which looks worse than it did just a few weeks ago. The fundamentals are, that instead of a serious recovery, you're getting if anything a slowdown. The fundamentals were already there, it's just that the markets have only just woken up to them.
What's the impact on the UK?
We should be worried about our growth prospects quite seriously. Europe and the US are where our exports go to. It's entirely possible that both 2011 and 2012 will be slow-growth years. You can just about live with slow growth in 2011 but if it continues for much longer then it starts to have an impact on our deficit reduction strategy. You need growth to have the revenues to reduce our deficit, if you don't have that then you have to make more cuts, and then you have a vicious circle situation.
There is flexibility in the UK's plan to allow for periods of slow growth, but if the international situation makes it difficult to grow, then it makes it more difficult for the banks to lend more money and that would affect our exports negatively, so you're going to be hard-pushed to find areas where growth will come from.
The UK's policies are correct in terms of having loose monetary policies, but they need to be constantly reviewed - possibly extra quantitive easing, maybe offering capital allowances to businesses. All that, I think, needs to be part of a package which the government may need to start implementing in the new year if the economy doesn't show signs of sustained recovery. It will bounce back a bit from 0.2 percent in the last quarter, but if there isn't a recovery next year then we will see rising unemployment which will start to have a serious impact on the deficit.