Page last updated at 12:54 GMT, Friday, 8 August 2008 13:54 UK

Solutions may make credit crunch worse

By Sir Howard Davies
Director, London School of Economics

Sir Howard Davies
Sir Howard Davies, a former CBI head, says some 'solutions' could harm the economy

It is 16 years since the British economy was last in a recession.

Most of our leading politicians and bankers have forgotten what it's like. They will soon relearn.

We are not quite there yet but to me it feels like one of those days where your throat begins to ache, you may tell yourself you are ok but you know a cold is coming on.

So it's not surprising that there are calls for the government to act.

Golden rule

For Gordon Brown to sit in Suffolk like King Canute while the waves lap around his deck chair just won't wash. He must do something for goodness sake if only say goodbye.

Unfortunately some of the solutions on offer could well make things worse.

Cut interest rates sharply? But what about inflation which is way above the target?

The best thing may simply be to hunker down and wait for prices to adjust and for the banks to restore their reserves so they're once again willing to lend

Increased public spending? We are already in breach of the government's own golden rule to borrow only for investment.

Some argue that we should act directly in the mortgage market.

There were calls for a new government agency to back mortgages. After the costly problems of Fannie Mae and Freddie Mac in the US that doesn't look too clever either.

What about cutting stamp duty? Well the Conservatives proposed that idea so on recent form there is a good chance the government may take it up.

But is it right to encourage first time buyers to get into the market when prices are falling sharply?

Heads to roll?

It may sound like a counsel of despair but the best thing may simply be to hunker down and wait for prices to adjust and for the banks to restore their reserves so they're once again willing to lend.

If the wholesale markets remain closed, it might help if the Bank of England were willing to accept new packaged mortgages as security for loans.

They won't be keen but it could be the least worst option.

There is perhaps one other thing.

In the US and in Switzerland, the heads of the worst affected banks have fallen on their swords. Nothing so embarrassing has happened here.

A few bankers taken in tumbrils to the Tower of London wouldn't do much to revive the housing market but it may cheer people up.

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