Page last updated at 23:13 GMT, Tuesday, 20 January 2009

What happens when the dust settles?

When will the stockmarkets recover? Will we ever see a return to the growth rates of the last decade? How far will Britain's housing market crash? Are we heading for massive deflation or Zimbabwe style inflation? Are we seeing an end to capitalist freemarket economics?

BBC Radio 4's In Business put these big questions and more to some of the UK's leading economists, who have all lived through several recessions.

Looking beyond the daily headlines, they put forward their predictions for the long-term future health of the economy.

Sir Howard Davies
Sir Howard Davies
Director of the London School of Economics

Michael Husghes
Michael Hughes
Independent Economist

Andrew Hilton
Andrew Hilton
The Centre for the Study of Financial Innovation

Roger Bootle
Roger Bootle
Economic Adviser to Deloitte

Jim O'Neill
Jim O'Neill
Head of Global Research, Goldman Sachs

Sir Howard Davies

Sir Howard Davies is the Director of the London School of Economics, and a former Chairman of the City regulator, the Financial Services Authority.

I think that people would now say - and here we speak with the benefit of hindsight, of course - that the systems to constrain the overall growth of credit in the economy were not in place.

But I think in retrospect, we can see the regulators did not have a mechanism for putting a shot across banks' bows on the basis of saying "look, asset prices are rising very sharply".

This must increase the probability or the possibility of a bust and, therefore, you should be salting away higher reserves which you may need if this bubble actually deflates.

At the moment regulators do not have that tool. It's being worked on now and I expect it to be in place in the future.

I think that there's no longer the same kind of embarrassment about the role of the state and the role of regulation.

When I was a regulator, people would constantly regard you as a tiresome aspect of their life and it was part of the normal political rhetoric to complain about regulators.

Every time I went to Parliament, I used to get beaten up by parliamentary committees for getting in the way of the wealth creation, animal spirits, etc.

We've now re-centred that debate to a more mature debate, I think, about the relationship between the state and the financial sector.

A new social contract, as I like to think of it, will be drawn up between the authorities - the Treasury, Bank of England and regulator - and the financial sector. I think on the whole that's going to be healthy.

Michael Hughes

Michael Hughes is an independent economist, and formerly Chief Investment Officer for Barings and Chief Economist for Barclays Capital.

I think this is the beginning of a new era. We'd had a remarkable period where people became very wealthy.

In fact by the end of 2007, the wealth of individuals in the UK was eight times their income and that compares with the long-term average of somewhere between three and four times.

So people became very wealthy and very confident because their house prices had gone up, share prices obviously had gone up, and so indeed had you know various other assets.

But of course that doesn't last and what we've now started to see is an adjustment in all these markets and I don't think we will see the confidence rebuilding probably for a generation, so I'd be looking at nearly twenty years.

In the case of the UK particularly where housing is such a big part of our lives, that is now being questioned as well because house prices frankly have only begun to fall and if you look back in time they peaked in the second quarter of 1989 but they didn't reach a trough until the fourth quarter of 1995, so that's six and a half years later.

Arguably this time it's going to be a bigger cycle.

The peak that we saw in 2007, in the third quarter of 2007, may not deliver a trough for about ten years onwards, somewhere around 2017.

So against that particular background, I don't think people are going to feel making money through housing is going to be as big a part of their lives as it has been.

Andrew Hilton

Andrew Hilton is Director of the think-tank The Centre for the Study of Financial Innovation and is an expert on banking.

I think we're at the end of the beginning. We are just able to see light at the end of the tunnel as far as the first phase of the financial crisis is concerned.

But it was a financial crisis. It's now generating a second phase, which is a major economic setback; a setback on a scale which we haven't really seen since the 1930s.

We're responding to that by pouring huge amounts of cash into the system. We're up to our eyeballs in cash and yet nothing really seems to be working.

We're going to have a wave of corporate defaults; and as we have that wave of corporate defaults, we're going to have a second phase of the banking crisis.

And of course that second phase of the banking crisis is going to make credit much, much harder to obtain anywhere else in the economy.

This will mean that there will be a second phase of the economic crisis, and I don't see how we get out of it.

Do we need big banks? Maybe we can do without big banks.

Maybe there are other ways to transfer money from those who have it to those who need it.

There are already on a small scale all sorts of small Internet exchanges, which do much of the same kind of thing as banks have done at a much lower cost. Maybe they can be scaled up. Maybe the Government can play a role here.

We don't necessarily have to continue the same banking model going forward, even at the retail level, as we have had in the past.

Roger Bootle

Roger Bootle is Economic Advisor to Deloitte's, the business consultancy firm. In Business asked him, when the dust clears, is deflation going to be the great worry?

I think it's a mark of how serious the current position is that in my view there's both a danger of deflation and inflation. I think this is a question of timing. The immediate danger is deflation.

We're going to see it, I think, in most developed countries - in a technical sense anyway: falling consumer prices as a reaction to the weakness of oil and commodity prices and, in the UK's case, the cut in VAT. These things are going to force down the measured rate of inflation.

We're going to see in many cases pay being cut, we're going to see firms forced to cut prices
But in a less technical sense, in a more general sense, the depression is going to eat away the inflationary pressures.

We're going to see in many cases pay being cut, we're going to see firms forced to cut prices. There's a lingering danger, I think, of deflation in a more genuine, serious sense.

I don't think the sort of deflation we had in the 1930s is a serious prospect - that's to say prices falling 10, 15, 20%, huge wage cuts. I don't think that's on. But the Japanese type deflation, a grumbling deflation, I think that's a serious prospect.

Now in order to avoid inflation, what's going to have to happen is that these measures being taken by banks and governments around the world will have to be reversed.

If you like, if you think about helicopters flying over the world and dropping huge quantities of pound and dollar and other currency notes. What's got to happen is the helicopter has got to fly around again with a gigantic vacuum cleaner sucking them all up again.

But then are they likely to err on the side of under doing it or over doing it? My own view is that we're likely to find that the governments have not done enough to expand demand and that they will adopt contractionary policies too soon, and that the result will therefore be the grumbling deflation of which I've spoken.

Jim O'Neill

Jim O'Neill is Head of Global Economic Research for Goldman Sachs, and is well known for his long-term predictions about the rise of the BRIC countries - Brazil, Russia, India and China.

I think this crisis accelerates the relative shift to the BRIC countries.

At the core of this crisis is really the end of the over leveraged US consumer.

In the near term it's causing problems for everybody around the world, including the BRICs, but I think it accelerates the shift to the new world of the BRICs .

I personally think it won't be as big a difficulty for China to cope with as many other parts of the world. Certainly in the near term, it's a problem and growth in China will for the first half of this year be below 8%, but I would be very surprised if by the second half of this year and into 2010 domestic demand hasn't replaced a lot of these lost exports.

The UK might not end up being quite as critical a mess as many people seem to popularly think here in Britain

I do think it means that Chinese consumption along with infrastructure investment can rescue Chinese growth back above 8% before this year's over.

One of my more controversial tips for this new year is that the pound's going to recover.

I think the pound has fallen so far, it's now very cheap. Business people all over the world can do things in the UK that you would have never have dreamt of doing before, including manufacturing.

With better policies to add to what's already happened, the UK might not end up being quite as critical a mess as many people seem to popularly think here in Britain.

I do think the degree of dominance of the UK economy by the financial sector is certainly past its peak, but the idea that the international services, including finance businesses, are finished in Britain is just very wrong in my opinion.

Listen to In Business on BBC Radio 4 this Thursday, 22 January at 20.30 GMT or catch the repeat on Sunday, 25 January at 21.30 GMT. You can also listen to In Business on the BBC iPlayer or subscribe to Peter Day's World of Business podcast.

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