Page last updated at 20:30 GMT, Friday, 9 January 2009

Martha Kearney's week

By Martha Kearney
Presenter, BBC Radio 4's World at One

Desperate times require desperate measures.

In private conversations ministers are no longer talking of recession, but deflation.

At the heart of the crisis is the fact the banking system is not working. So how can lending be increased?

Chancellor Alastair Darling
The chancellor insisted this week that he wasn't going to 'print money'

The measure of last resort is "quantitative easing" (QE), a phrase which has crept into our editorial meetings of late but was not on everybody's lips six months ago, it has to be said.

This is sometimes described as printing money to bring greater liquidity into the system.

The chancellor has said QE is a purely hypothetical option, but I understand this is under active consideration.

Ministers have been studying how it worked in the past and point out that this was the only lever not used in the 1930s.

So when might we see it introduced here?

Risk of deflation

"We're not there yet," I was told, "But in Japan, there was too little easing too late."

Government sources have also been studying the United States where quantitative easing has been happening behind the scenes for a while and publicly from mid-December. They believe it came too late in the process there too.

The Bank of England would buy government bonds or commercial ones from the banks, exchanging illiquid assets for cash to increase liquidity.

In normal times this increase of the money supply would fuel inflation, but the risk now is of deflation according to one highly placed source, who maintains that it would be the Bank's statutory duty to begin QE as part of its responsibilities on monetary policy.

There are some indications that the banks which took capital from the government are lending more, but the underlying problem is that so many lenders have disappeared from the scene like the Icelandic and Irish banks.

The government argues that this is exactly the wrong time to take money out of the economy by reducing the levels of government expenditure.

There is no appetite in government to set up its own bank, but I understand it may well use Northern Rock, the bank it owns, to increase lending.

At the moment there is not much demand for mortgages, but ministers are worried that when it picks up, there will be a big capacity problem.

All of this is an acknowledgement that lower interest rates on their own are failing to boost the economy. Meanwhile, savers are being badly hit.

Save, save, save

In 1961, Vivien Nicholson, a Yorkshire housewife won 150,000 in the football pools. When a reporter asked her what she planned to do with her new fortune, she famously replied: "I'm going to spend, spend, spend!"

That story ended in misery as wild shopping sprees and five husbands led her to bankruptcy.

This week, David Cameron invoked Vivien Nicholson's notorious phrase when he said he wanted to create a Save, Save, Save society rather than a Spend, Spend, Spend one, attempting to draw a contrast between apparent Labour profligacy on public spending and Conservative prudence.

David Cameron
David Cameron says the Tories are not the 'do nothing' party

The Conservatives came back after the Christmas break determined to rebut the charge that they are the "do nothing" party, a criticism constantly being made by Labour.

That's why they proposed tax cuts for savers and are pushing a National Loan Guarantee Scheme to help the banking crisis.

Under Cameron, basic rate tax payers would no longer have to pay tax on the interest from their savings.

This was a clever move ahead of Thursday's interest rate cut which meant savers getting even less return on their money.

But there are pitfalls too. One expert calculated for us that the amount of tax saved in the halcyon days of 5% interest rates would be quite small and would be "lost in the wash," as he put it.

The Institute for Fiscal Studies also told us that in order to raise the 5bn to pay for this, there would have to be severe savings made in the departments singled out for cuts in their growth of spending.

The government argues this is exactly the wrong time to take money out of the economy by reducing the levels of government expenditure.

It is continuing on the Keynesian "spend, spend, spend" model, hoping to prime the pump. It will be some time before we discover what has been working.

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