SO, WHERE do we go from here? Yesterday, the Bank of England cut interest rates by half a point to 1.5 per cent – the lowest level in its 300-year history.
But it was coolly received by business and financial markets.
"Too timid," said the Engineering Employers Federation.
"Cutting rates has so far done little to get the economy back on track," said the accountant Grant Thornton.
"Would have liked to have seen a more bold approach," said Liz Cameron, from the Scottish Chambers of Commerce.
But few now believe the cost of money is the heart of the problem – and fewer still that this latest cut will make much difference in staving off a deepening recession.
After a breakneck series of rate cuts, government-backed rescues of banks and unprecedented levels of cash injections into wholesale money markets, policymakers have exhausted almost all conventional solutions.
We are now flying blind through this storm.
And the Bank is now down to the last shot in its locker. A further half-point cut to 1 per cent – widely expected next month – will leave Britain's central bank with its armoury virtually spent, and with no sign of any immediate easing of the downturn. Yet last year, the universal cry was that lower interest rates would turn the tide.
Economists urged rate cuts as the most effective means of countering the credit crisis and its impact on the wider economy. Yet rate cuts – and all the extraordinary measures taken by the government and the Treasury – have so far failed to slow down, still less halt, what is shaping up to be the worst recession since the Second World War.
Now there is talk of an altogether more desperate solution: "quantitative easing", or a resort to printing money to counter the feared onset of deflation.
Amid the deluge of reactions to yesterday's rate cut, that from the RBS economist Stuart Porteous was the shortest – and the most pointed.
"As rates head towards zero, policymakers will be forced to embark on ever more unorthodox measures to get the economy moving again," he declared. "Listen carefully and you can almost hear the printing presses being cranked up".
The next stage in the crisis is likely to involve detailed discussions between government and the banks on how to stimulate lending. There will also be intense talks with Bank of England officials on how fresh funds can be channelled into the banks in a way that will ensure they are given as loans to hard-pressed businesses.
The deepening scale and depth of the recession – and the stark failure of official action so far – was evident in the bleak statement accompanying the Bank's rate-cut decision yesterday.
"The world economy appears to be undergoing an unusually sharp and synchronised downturn," it said.
"Measures of business and consumer confidence have fallen markedly. World trade growth this year is likely to be the weakest for some considerable time…
"In the UK, business surveys suggest that the pace of contraction in activity increased during the fourth quarter of 2008 and that output is likely to continue to fall sharply during the first part of this year. Surveys of retailers and reports from the Bank's regional agents imply consumer spending has weakened. The outlook for business and residential investment has deteriorated".
Little wonder the latest rate cut carried little conviction – or the one to come, for that matter.
The Bank's statement also highlights the poor state of credit supply and the need for more action on this issue, referring to "the need for further measures to increase the flow of lending to the non-financial sector".
It does not say what "further measures" it has in mind. But close observers expect it is mainly extra capital for banks on more generous terms, extra liquidity support and more generous debt guarantees.
The key to this crisis is confidence. And that is unlikely to return until the unprecedented measures already undertaken have had a chance to work through the system. For example, by the spring, many mortgage borrowers should be feeling the benefits of lower interest rates on monthly repayments.
But it is the slump in business confidence that is especially worrying. The government has staked its reputation on a recovery setting in during the second half of this year. But the worse the news flow from businesses, here and abroad, the less likely this now looks.
The government desperately wants to see the banks strengthened and stepping up their lending to business. But there is an immediate and direct conflict here between official concern to see bank credit expanding again and an insistence that banks should operate on a more secure capital base.
Since the viability of the banking system depends on maintaining general confidence in its capital strength, the priority for government would seem to lie in restoring the banks' capital position through recapitalisation and higher retained profits.
It is easy to exhort the banks to lend more. However, demand for lending is declining sharply as confidence retreats. Where there is demand, an equally acute problem is that banks' lending judgments in this environment are most likely to be highly cautious.
For example, they may cut back on lending to otherwise soundly based companies that happen to operate in credit-hungry business areas or where lending appears particularly high risk. Refusing to extend credit could send these business into administration.
The case for government involvement is that it can make good systemic defects by devising means to keep credit flowing to those businesses that see sources of bank finance drying up.
Further talks between government ministers and the banks are likely to focus on an offer of guarantees on loans the banks make to companies. The banks would then have no reason to fear losses on such lending, and would be more inclined to grant credit to borrowers benefiting from the guarantee.
However, the problem with this is the banks might still be constrained from lending by capital considerations, unless such loans were regarded as government debt and zero-weighted for the purposes of calculating banks' capital requirements.
Economist Stephen Lewis says: "If the government has to accept liability for the loans, if any scheme is to be viable, it might as well run the fund providing the finance. Setting up such a fund might, indeed, have been a more effective use for the £12.4 billion the UK government is spending on the temporary VAT reduction."
That would hand the banking industry, lock, stock and barrel, to the government. And not everyone would see that as part of the solution.
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Graphic: How interest rates have changed since 1694•
Business backing for Brown plummetsPROFILEWILLIAM Paterson, a Scottish trader and writer, founded the Bank of England to help a financially crippled government raise cash.
Born on a Dumfriesshire farm in 1658, Paterson lived in England, America and the Bahamas before coming up with the scheme in 1691. It finally came off in 1694.
The lenders were wealthy landowners and they were known as The Company of the Bank of England.
Paterson, however, resigned two years later after falling out with his directors. He moved back to Edinburgh and launched the doomed Darien venture.
After just one year in Panama, he returned broke and bereaved, having lost his wife and son.
Scotland had to accept the financial help of Westminster. This led to the Scottish Parliament passing the Act of Union in 1707. Paterson died in 1719.
Bang on the money or a fiscal fudge? The experts deliver their verdicts
Yes, it will work – eventuallyDAVID TINSLEY, UK economist at Clydesdale and Yorkshire banks:
History tends to suggest that these things do work eventually, although the time- lag can be quite long. When sterling fell out of the Exchange Rate Mechanism in the early 1990s, it took a good couple of years before UK exports benefited from the fall in the pound. Likewise, the fall in sterling this year will eventually make UK goods cheaper overseas, and also overseas goods more expensive here. That will have an effect on the UK economy. It all depends on the US, and probably to an equal amount on the Eurozone. You can't take advantage of a fall in the pound unless you have markets to sell into. Trying to sell into the US, and increasingly Germany, is very hard. With interest rates, we are in slightly uncharted waters because of a breakdown in the transmission mechanism – these cuts have been partially passed on to householders. We may have to look at measures to boost lending. In the meantime, we may see UK GDP growth go negative and employment fall.
It all comes down to the banks
STEPHEN GIFFORD, chief economist at Grant Thornton:
We are already moving past interest rate cuts to more innovative methods to increase liquidity and the money supply. The next step is this so-called "quantitative easing" – it's not really printing money, but it's increasing the money supply.
Most of the money in the UK economy is created by the banks. A single bank can't create money, but the whole banking system, through the way it lends to itself, creates money. But the system is collapsing because they're not lending to each other. There will be all sorts of ways they can do that. Holding interest rates for a year or two will put some sort of credibility back into the system. But it all goes back to this lending by the banks. If they don't lend to each other, we will continue in this malaise for a long time.
They have to rebuild their balance sheets, which have taken a hit over the past few years, from things across the Atlantic to too much lending. Now it's going in completely the other direction and they are hoarding cash.
New move won't work because cheap interest caused crisis
KEITH PILBEAM, professor of international economics at City University, London:
There are big problems with the interest rate cut. They are now so low that an extra 0.5 points is not going to make a great deal of difference. It's beginning to affect savers. We are trying to bail-out debtors but at the same time we are punishing savers. The net effect is quite small. The other problem is that the economy is going to get much worse. Unemployment is going up. That is a real problem because that hits confidence, and people start saving even more. People say we should get the banks to lend more money, but the banks have already lent their money. These Bank of England interest rate cuts are only for the short end of the market.
There are dangers in what we are doing with this unprecedented borrowing and the interest rate cuts, because that is what is led us to this in the first place. It's a vicious circle if people save money, but that is part of the process to get debt levels down. Sometimes it's better to have short-term pain for long-term gain.
A bankrupt nation, storing up trouble for the future
JONATHAN DAVIS, managing director of financial adviser Armstrong Davis:
A sterling crisis has been the by-product of the Bank of England's cuts to interest rates. We are experiencing corporate bankruptcies every second day and more home repossessions.
Because our country is so bankrupt and the government has been forced to borrow so much by selling gilts, there is a risk of inflation in the future. The investors who have bought UK government gilts will expect a return on their investment. This will again feed into inflation and we can expect a rise in interest rates. We can expect inflation to reach the double-digits of the 1970s by the middle of the next decade.
The bottom of the housing market is at least two years away.
The economy is falling and almost no amount of Gordon Brown printing money to save banks will help our failing economy.
To paraphrase Napoleon: "Britain is a nation of house-sellers and buyers." That is not the way to build a strong economy.
Companies' problems can't be fixed by lower interest rates
ALAN TOMLINSON, of UK licensed insolvency practitioner Tomlinsons:
The interest rate cut will inject some confidence into the business community, but for companies that are already struggling it will be of no real help. Interest on loans is only paid quarterly, so it cannot have an immediate effect.
Many of the companies we are advising at present have more fundamental problems, such as sharp drops in turnover, large debts and ever weaker pricing, which can't be rectified by lower rates. For many companies out there, this will be too little, too late. Many of our clients have reported a 30 per cent drop in business over the past year.
These are often family businesses, which make up the backbone of our economy. Insolvency has lost a lot of its stigma, so we can expect more companies over the coming few years to come forward and ask for help.
This year is going to be fairly grim, but these events go in cycles. During the 1990s we thought the world was ending and yet new businesses emerged. The same will happen again.
Face the fear and do it anyway
GEORGE KEREVAN, associate editor of The Scotsman:
The economy is like a boat. Occasionally it gets knocked over by a big wave called a financial crisis, when banks lend too much in a fit of optimism only to discover borrowers can't pay back.
Fortunately, the boat usually rights itself after 18 months, as consumers clear their debts and banks recapitalise. This happens regardless of what governments do.
But what if consumers become so fearful they won't start spending again (as happened in Japan in the 1990s)? There are two options: export more or tax people who save. And if banks won't start lending again the government has the option of nationalising them and doling out cash itself.
However, at the root of all this is a little thing called "confidence". If the usual economic levers (interest rate cuts) are not working, it is because confidence has expired.
The ultimate solution is some intangible psychological boost such as US president Franklin Roosevelt's famous inaugural line in 1933: "We have nothing to fear but fear itself".
Over to you, President Obama.
