14/03/2008

Policy makers boxed in

Various risks and pressure points in the world economy have recently become more threatening. Policy makers have limited options due to problems created by past mistakes and much more serious pain may be required before some solutions become politically acceptable, according to research published today by leading investment house, Standard Life Investments.

In the latest edition of Global Insight, its monthly investment view, Standard Life Investments examines the room for manoeuvre facing policy makers in different countries.

Andrew Milligan, Head of Global Strategy at Standard Life Investments, said:

“The world economy is under considerable pressure. The US slowdown is rippling out to other countries, as shown in global trade flows. Less credit is available for many organisations and individuals. Falling share prices and rising corporate bond yields indicate that investors are pricing in a much more subdued environment for future earnings growth, and a sharp rise in foreclosures, bankruptcies and debt defaults in coming months. Investors have moved on from debating ‘will there be a US recession’ to ‘how long might the period of weak growth last’ and ‘how widespread could a global downturn become’?

“Policy makers are responding, but they face limitations. The monetary transmission mechanism is damaged in some countries. Official rates have fallen sharply, resulting in a steep yield curve, a traditional route to restore bank margins. However, the benefits of lower rates are not flowing through to the private sector as banks restrict credit availability. A further problem is that many central banks have not been able to follow the US lead, as inflation is above the desired level. Lastly previous mistakes in fiscal policies in several countries restrain the ability to cut taxes or raise spending levels. Despite a period of positive economic growth, public sector finances were not put onto a stronger footing.

“Ultimately, a combination of a steep sustained yield curve across most of the largest economies, ‘self help’ capital injections into banks, and a transfer of debts from the private to the public sectors, are traditionally required to bring a period of debt de-leveraging to an end and provide the foundations for a sustained period of growth. Political barriers to such actions will determine the speed with which they could be implemented.”