In an interesting article by Dennis Turner, Chief Economist, HSBC, he outlines some of the details of the current recession and his view of what happens next:

Economic downturn, global financial crisis, credit crunch… Which ever way you look at it, the UK is experiencing a recession and we’re all affected by it. Our Chief Economist, Dennis Turner, looks at how the recession started and how long he thinks it will last.

Why is the UK in recession?
The economy has been so good for so long that many people believed that boom and bust was a thing of the past. But we are now being called to account because we have relied for the 16 years of unbroken growth and pretty near full employment on consumer spending and borrowing and government spending and borrowing. We have had a very unbalanced economy with investment and exports not really making a full contribution. It was unsustainable but, because the correction has been delayed, the bump will be a bit bigger.

Why now?
Over the last decade household debt has been building up, to the point where consumers collectively now owe around £1.4 trillion. In other words, everyone owes on average about 19 months’ pay. Not only are consumers now unable to borrow more to support spending (partly because the fall in house prices has removed the option of equity withdrawal), but a combination of higher debt repayments, higher taxes and rising prices for many essential items is squeezing disposable incomes with the pressure being felt particularly on discretionary spending. The rise in unemployment will, of course, add to the problem by reducing the total amount of available spending power in the economy.

What about the rest of the economy?
An environment where consumer demand is falling will lead to cutbacks in production. Industries from construction to retail to travel are all feeling the squeeze. This is not an environment that will encourage businesses to invest. In addition, talk of falling prices is a further disincentive. On top of this, the global slowdown (recession in the EU and US) will make life tougher for exporters, a possible escape route for companies facing a tough home market. So, with companies and households, which together account for 75-80% of final spending, clearly in retreat, there is a hole in the economy that will depress activity.

What happens in a recession?
As the economy slows, jobs are an early casualty, and already unemployment is rising as businesses fail or cut back. Government spending finances tend to weaken as tax receipts fall away and social security spending rises, which pushes out the prospect of further tax cuts. With weaker demand, prices tend to fall and earnings growth slows. This allows the authorities to cut interest rates, which is good news for borrowers but not so good for savers.

What action can the authorities take?
What can be done is being done, and very decisively. Chancellor Alistair Darling, working on the principle that everybody’s expenditure is somebody else’s income, has stepped up to fill the gap left by a constrained private sector. Taxes have been cut and spending stepped up (financed by borrowing for which we will be paying for years to come). In addition, the Monetary Policy Committee has cut interest rates to their lowest level since the Bank of England was founded in 1694. Finally, Sterling has slipped against the Euro and Dollar, which will give UK exporters a bit of an edge in difficult world markets.

Will the initiatives work?
If it was only the economy, this could be quite a short and shallow recession. All the measures the Major government took successfully to end recession in 1992 have been used again. But today there is the credit crunch as well. This is a problem about banks, individually and their relationships with each other. It was not caused by the recession nor did it cause the recession, but the collateral damage could slow the pace of recovery. Companies and individuals need credit to function normally on a day-to-day basis and even though interest rates are low, raising the appropriate money is a real problem. This is why the government has spent as much time and even more money trying to get the banking system back on an even keel so as to boost the economy.

Is there anything else the policymakers can try?
Much of the money that has so far gone into the banking industry has been used to rebuild banks’ balance sheets rather than for new lending. To stimulate lending, the authorities have begun the so-called ‘quantitative easing’, which is in effect printing money. There are various ways they (primarily the Bank of England) could adopt to get cash into the system, thus enabling banks to lend again and, with interest rates historically low, encouraging borrowing and spending. There are risks with this policy, which some claim ‘debases the currency’, particularly related to the exchange rate and inflation, and it is a last resort.

How long will the recession last?
All the indications are that this downturn will be as bad as any post-1945 recession and the next few months will be the low point in terms of falling output. Economists are currently playing a game of alphabet soup to describe the recession, such as ‘V’ shaped (short and sharp), ‘U’ shaped (bump along the bottom for rather longer), ‘W’ shaped (a double dip recession) or the ultra pessimistic ‘L’ shaped. But the recession will end, because recessions always end, and probably by the fourth quarter of this year, recovery will be back on the agenda. Unemployment will, however, probably continue rising into 2010 as will business failures as the economy takes time to move back to normal or ‘trend’ growth. The imbalances in the system have built up over a number of years and will take time to unwind – and this is just the start of the process.