Free Storm, The by Vincent Cable

countries, such as Hungary, have suffered from the withdrawal of the Austrian banks. Icelandic banks extended themselves
     way beyond the capacity of the Icelandic government to provide lender of last resort support and lending banks collapsed,
     leading to a withdrawal of credit as well as to losses for depositors in areas where there was a dispute over jurisdiction,
     as was the case with deposits in the Isle of Man and the Channel Islands. Irish banks also became overextended in overseas
     markets and have since withdrawn. An estimated 30 per cent of UK lending disappeared as a consequence of the problems experienced
     by overseas banks. Over the last year, there has been a retreat from cross-border lending generally and the appearance of
     what has been called ‘financial protectionism’. It is easy to understand how this problem has arisen. Global banks were not
     rescued by the globe but by their own national authorities and taxpayers, who, unsurprisingly, have wanted them to focus on
     lending within their own national economies.
    There is as yet no clear sign of a reversal of the contraction in lending – which is also what occurred in the ‘great contraction’
     from 1929 to 1932. It is precisely because of the institutional memory of that disaster that the pressure has mounted on the
     authorities to offset the deflationary risk. Deflation arises because firms slash prices, and wages, in order to survive.
     However, consumers, expecting still further price cuts, hold back from spending, thus worsening the outlook for companies
     even further and forcing down prices, in a downward spiral. Pre-war experience suggests that it then becomes essential, in
     this unusual set of conditions, to provide a monetary stimulus by cutting interest rates, and a fiscal stimulus by, temporarily,
     running a larger budget deficit than would normally occur even in a downturn.
    Until just recently, all the major developed countries’ central banks have been trying to balance inflationary against deflationary
     risk. Their assessment of risk has been heavily influenced by history. The approach of the Federal Reserve is dominated by
     lessons learned from the 1930s; that of the European Central Bank by memories of hyperinflation; and that of the UK by recent
     experience of inflationary wage–price spirals. The USA, like Europe, had good reason to worry about inflationary risk, since
     consumer price index (CPI) inflation had recently passed 5 per cent and inflation expectations, as measured by survey data
     and by the gap between real and normal bond yields suggested, until an advanced stage of the crisis, that inflation would
     increase.
    To set alongside these concerns, however, was the growing worry that a credit squeeze would hit spending and growth; that
     a falling housing market would depress the sense of well-being and willingness to spend; and that unemployment would add to
     housing market defaults and overall lack of confidence. Deflation was thus becoming a greater risk than inflation, and were
     deflation to take hold it would increase the real cost of debt and make the drag of debt on the economy all the more severe.
     By November 2008 it was clear to the US and UK authorities – and even to the more reluctant European Central Bank – that interest
     rates shouldbe cut drastically. A year later, leading central banks judged deflationary risk still to be very real, and while there is
     talk of an ‘exit strategy’ for easing monetary policy, it is still some way off.
    The US authorities in particular, led by Mr Bernanke at the Federal Reserve, have had no inhibitions in taking an aggressive
     stance, particularly on monetary policy. There was a deep cut in Federal Reserve Funds interest rates, from 5.25 to 2 per
     cent, at the onset of the crisis, almost as radical and more abrupt than the cut from 6.5 to 1 per cent in response to the
     perceived threat in the 2000–1 period. The Bush, then Obama, administrations