Tejvan Pettinger

Recently, the IMF have been working hard to establish a bigger fighting fund to help out insolvent Eurozone economies. (Although they say, it is not just for the Eurozone, but for the whole world economy.) Extra contributions from IMF members have raised an extra £300bn – taking the total of IMF funds to £1,000bn.

• The aim is to have a bigger ‘firewall’. If economies experience liquidity crisis – e.g. can’t meet borrowing requirements, then they can apply for a loan from the IMF.
• The fact that there is a lender of last resort like the IMF – means markets are, in theory, less worried about countries becoming illiquid and experiencing shortages. This confidence factor can help avoid capital flight in the first place.
• Given the greater uncertainty in the world economy, the IMF has been keen to build up an even bigger fund than usual.

How Do Countries Contribute to IMF?

• The UK recently gave £10bn to the IMF. This doesn’t come out of public spending. It is invested from UK foreign exchange reserves. The UK can also gain interest on this ‘investment’ into the IMF fund.

Limitations of the IMF Fund

• One Trillion pounds is a big fund, but given the amount of potential losses in the Eurozone, it would be insufficient to cope if countries like Spain or Italy defaulted.

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Preliminary figures for Q1 2012 show the UK has re-entered recession, with a second successive quarter of negative economic growth.

The negative economic growth occurred despite a small growth in the service sector and spurt in retail sales of petrol. The biggest factor contributing to the negative economic growth came from the construction sector, which saw a drop of 3.0%.

Brief Summary on Causes of Double Dip Recession

• Spending Cuts – creating lower wages, unemployment and decline in confidence
• Cost-push inflation and decline in real wages. Workers are seeing a squeeze in incomes leading to lower spending
• Uncertainty in housing market causing a drop in construction
• Uncertainty in Eurozone holding back investment and spending.
• Slower exports to the Eurozone facing its own economic downturn.
• More on causes of double dip recession

Implications of Double Dip Recession

After the serious 2008/09 recession – where GDP fell a record 6%, the economy has struggled to recover.

• Despite the spare capacity, inflation has remained above target, giving little room for manoeuvre. At least one member of the MPC have started talking about the prospect of interest rate rises sooner than later. But, this news of economic recession, will give more weight to the inflation doves who are more concerned about lack of growth and unemployment.

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Readers Question: Why is the current recession in Europe so bad?

The recession in the Eurozone is one of the deepest recessions on record. For example, Greece are expecting 2013 to be the sixth consecutive year in recession (with on and off quarters of recovery)- this is  one of the longest recession on record. Output in Greece is 16% lower than at the start. Other countries such as Spain, Ireland and Italy also face large falls in GDP, which have been much more prolonged than previous recessions.

There are a number of reasons why the European recession for Eurozone countries is so severe.

1. Spending Cuts

Faced with budgetary constraints, countries have been forced into ‘austerity measures’ For example, Madrid has been set a target by the European Commission of reducing the country’s budget deficit from 8.5 per cent to 5.8 per cent by the end of 2012, and to 3 per cent in 2013. This level of deficit reduction is difficult in normal circumstances. But, if you cut spending when economy is already in recession, then there will be a large fall in domestic demand and rise in unemployment. Spain already has an unemployment rate of 20%, spending cuts will inevitably worsen the unemployment problem.

2. Legacy of Asset Price Bubble and Household Debt.

In the boom years, countries such as Ireland and Spain both had a rapid increase in house prices. After the credit crunch,  house prices have fallen by upto 40%, leaving many banks, business and homeowners facing higher levels of personal debt. This personal debt creates a big drag on spending. Households face the prospect of trying to pay off debt rather than spend. UK’s personal debt stands at £1.4 tn (close to 100% of GDP – up from 69% of GDP in 1997 link) This is known as a balance sheet recession.

A graph (EV) showing the rapid fall in real per capita housing equity in the US. – A major drag on US consumer spending.

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