Nobody really knew it at the time but 10 years ago the world was sitting on the edge of the precipice. It seemed like a normal sleepy August but the calm was illusory. The global financial system was seizing up. The collapse of Lehman Brothers was but a month away.

Eventually policy makers finally understood the enormity of what was happening. They responded swiftly and decisively as the crisis spread from the banks to the rest of the economy. They needed to. During the winter of 2008-09, trade and industrial production were collapsing more quickly than they had during the Great Depression.

Interest rate rise: lack of dissenting voices came as a surprise Read more

Now imagine if something similar were to happen again. It is not the likeliest of outcomes but not all that far-fetched either. China’s debt; Brexit; a global trade conflict: any of them could blow up into something serious. These sort of events form the basis of the war games that policy makers play from time to time.

In the winter of 2008-09 action was taken to prevent a deep recession turning into a 1930s-style slump. What’s worrying is that it might not be possible to do the same again, at least not by the means used last time.



There are at least four ways in which policy is more constrained than it was a decade ago. First, and most obviously, there is monetary policy; the options available to central banks. At its August meeting in 2008, the Bank of England left interest rates unchanged at 5%, which meant it had plenty of scope to cut when it finally woke up to the seriousness of the situation. Even after last Thursday’s rate rise, official borrowing costs are only 0.75%, providing much less room for manoeuvre.

One of the small comforts from the crisis of 2008-09 was that it generated a sense of international solidarity

Back in the summer of 2008 only economists had heard of quantitative easing but the term was soon in widespread use after central banks embarked on bond-buying schemes designed to boost the supply of money to their economies. In the event of a crisis, central banks would cut interest rates to zero and resort to more QE but the law of diminishing returns suggests the impact would be less powerful than in 2008-09.

Then there’s fiscal policy, tax and spending decisions made by finance ministries. In Britain, the budget deficit – the gap between what the government spends and what it receives in taxes – expanded rapidly during the crisis from 2% of gross domestic product to a peacetime record of 10% of GDP. It has taken 10 years to bring the deficit back to where it started and meanwhile national debt as a share of the economy has more than doubled to over 80% of GDP. Despite a prolonged austerity drive, set to continue well into the next decade, the public finances are in worse shape than they were when Lehmans went bust.

One of the small comforts from the crisis of 2008-09 was that it generated a sense of international solidarity because the world’s biggest economies quickly realised they need to help each other. There was a collective commitment to shore up banks; the creation of a new body, the G20, to bring together developed and emerging market economies; as well as an agreement to refrain from protectionism. As Adam Tooze notes in his new book about the crisis, Crashed, the US Federal Reserve quietly acted as the lender of last resort to Europe’s troubled banks.

The collaborative mood did not last for long. Europe and the US went their separate ways over austerity; the G20 failed to live up to its early promise and even before the arrival of Donald Trump in the White House, countries had quietly been finding ways to defend the interests of domestic producers. Trump has, of course, taken isolationism to a whole new level by picking trade fights not only with China but with the EU, Canada and Mexico as well. In the current beggar-my-neighbour environment, the chances of the world coming together in the event of a new crisis appear slim.

There is one other significant difference between now and a decade ago: the political climate. The last crisis came at the end of a prolonged upswing, in which wages and living standards rose steadily. Britain went 16 years without a single quarter of falling output and in the latter part of this period, when Labour was in power, there was bountiful investment in the public sector.

Feast has been replaced by famine. Wage rises have turned into pay freezes; living standards have stagnated and the public sector bears the scars of a decade of cuts. Austerity fatigue has set in, making it nigh on impossible for governments to insist that voters endure a new round of sacrifices. The public mood is already sour.

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To summarise, the scope for monetary policy is limited, finance ministries are wary of borrowing more, the international community is riven and populism is on the rise almost everywhere.

So what options are there? Initially, the response will be more of the same: monetary and fiscal policy will be eased to the extent that it can be. But if that does not work, more radical ideas will be canvassed, including reducing the size of the state; negative interest rates; a more targeted form of QE to fund infrastructure; and tax cuts financed by the printing of money.

None of this is currently in prospect. Yet back in August 2008 the Bank of England thought growth would be flat over the coming year if interest rates were kept at 5%. There was no suggestion that six months later interest rates would be 0.5%, QE unveiled and an emergency VAT cut announced. The lesson of 2008 is that in a crisis the impossible can become possible very quickly.