What is the present outlook?

In the US we’ve now had five months of employment going down and the number of hours worked has declined precipitously. If you focus on employment we are already in a downturn [whether or not it is technically yet a recession].

Is it likely that this dynamic is going to turn around in the next six months? Probably not. It’s likely to get worse.

The best estimate on the housing market is that we are only halfway through the declines.

Will tax cuts and sovereign funds come to the rescue?

Since the introduction of tax cuts in the US in February, the increase in the price of oil has taken out of consumers hands more than twice the amount of the tax decrease.

In the first round of the credit crunch banks could get money from sovereign wealth funds. Now there are stories that sovereign wealth funds feel the problems have been under-represented and that they are less welcome.

They may still be willing to come - but only if they get a good deal. That means dilution of shareholders and loss of control.

What about oil?

The price of oil has gone up fivefold since the Iraq war. But there is little incentive for producers to pump more now. If Goldman Sachs says the price is going to be $200 in a year’s time, you wait for a year and double your money.

There’s another factor. [Producers] can’t really spend all that money that fast. What are you going to do with it? Put in the US, where the value of the dollar is decreasing and your funds may be frozen at any moment if you are declared a terrorist state? Or do you want to keep your money in the ground?

Obviously you should do both, but the answer is pretty clear.

Why were warnings of trouble ignored and who’s to blame?

Too many people were making too much money. Those in the financial and real estate industries were making so much money they wanted to believe they were doing the right thing. There’s been a lot of self-deception.

The Federal Reserve is very guilty. In a myopic way it decided to flood the economy with liquidity. People created a bubble to keep the economy going. It should have been very clear they were creating a bubble: when savings are zero, when people are giving 100% mortgages, when real incomes are going down and house prices are going up - there’s a disjunction there.

It was a massive fraud, a pyramid scheme, arbitrage, financial alchemy, self-deception - call it what you will.

This is the third financial crisis in three decades. The financial institutions argued that their genius in managing risk and increasing efficiency justified their high salaries. Many people are questioning that. They said they deserved to be taxed at low, low rates because they induced benefits that would accrue to all society. That’s being questioned, to put it mildly.

Caught between a downturn and inflationary threats what should we do?

We need to worry about inflation, but we need to recognise that we can’t stop imported inflation [of oil and food prices]. We can get the average inflation number down by killing wages so much that other parts of the economy have falling wages and prices. But that cure is worse than the disease.

In effect what you are doing when you do that is putting the burden of adjustment on workers. [But] in the US real incomes have fallen already since 1999 for more than half of America. It’s extraordinary.

Moderate inflation, under 8% to 10%, does not have any significant effect on growth. I would try to work on the idea of a new social contract.

We are poor because of an increase in the price of oil - how do we share the burden? Let’s try to do it in a way that protects people at the bottom.

Explore Economics

• Pre-Budget Report 2008

• Budget 2009

• World Economic Forum

• The Times MPC

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