Economy watch: What caused the return to recession and how long will it last?

By Andrew Oxlade
UPDATED: 06:56 EST, 6 July 2012

This is Money Editor Andrew Oxlade [@andrew_oxlade] explains the basics of a financial crisis that descended from credit crunch to recession to debt crisis: the latest, the story so far - and what to expect next (updated as events dictate - bookmark thisismoney.co.uk/recession)...

Enlarge  

Britain is officially back in recession. After the recovery failed to gain any traction in 2011 when the economy grew by a paltry 0.9 per cent for the full year. And 2012 has begun badly.

The economy shrank 0.4 per cent in the final quarter of 2011 and then another 0.3 per cent in the first quarter of 2012.

That marks a technical recession, something analysts had thought the UK would narrowly avoid.

It also means we're in the first 'double-dip' recession since the economic turmoil of 1975. 'Double dip' is where the economy goes back into a recession before it has had a chance to recover its previous high of economic output.

WHAT IS A RECESSION?

The technical measure of recession' is two 'quarters' of the year, back-to-back, where the size of the economy shrinks, as measured by GDP (Gross Domestic Product). 

We remain a long way from that 2008 peak - the economy saw below-par 2.1 per cent expansion in 2010 following a 6.4 per cent plunge during the 'Great Recession' of 2008-2009.

We're now in the longest slump in more than a century.

The graph below shows how the economy has recovered after previous recessions. This downturn has been worse than the Seventies, in terms of the trajectory of the economy, and even more severe than the Great Depression of the 1930s, when GDP recovered its previous high after nearly four years.

How the recovery from recession compares with those of the past

So what can we expect for 2012 as a whole?

The median prediction from analysts is for growth of just 0.4 per cent for 2012 with the gloomiest forecasters predicting the economy will shrink by more than 1 per cent.

To get a feel for how weak this is, the average annual GDP growth from 1990 to 2008 was 2.3 per cent. And most people - but not us - had been expecting the usual post-recession bounce back, as happened after the Eighties and Nineties recessions. So they'd have been hoping for growth of 4 per cent or 5 per cent a year.

GROWTH IN THE ECONOMY, YEAR BY YEAR

The Office for National Statistics constantly revises figures on the economy's growth, more than a decade after the event.

That's because the first estimate is based on only 40 per cent of the data.

These are the latest estimates (June 2012):

2011	0.8%
2010	1.8%
2009	-4.0%
2008	-1.0%
2007	3.6%
2006	2.6%
2005	2.8%
2004	2.9%
2003	3.8%
2002	2.4%

So what do the experts say?

The International Monetary Fund (IMF) is fairly upbeat. It upped its forecast for 2012 growth (17 April) from 0.6 per cent to 0.8 per cent. It cited the colossal efforts in February to avert eurozone meltdown by the European Central Bank, when it extended cheap lending to banks to £1trillion.

The OECD correctly called the recent double-dip in November 2011. It now predicts the economy to shrink 0.1 per cent over the whole of 2012.

A Markit survey called it badly wrong in early April suggesting the economy had grown 0.5 per cent in the first quarter but the OECD was far more accurate, calling a 0.1 per cent decline. [Read the full report]

This economic gloom is all of great concern to the Treasury. The Coalition's plans for the future hang on being able to cut debt [how big is Britain's debt problem?] with a mixture of austerity cuts AND economic growth. 

A return to recession would derail its plans.

At the November mini-Budget, the independent Office of Budget Responsibility dramatically slashed its projection for 2012 growth from 2.5 per cent - a prediction from March - to 0.7 per cent [read more].And in March 2012, the OBR forecast that the UK would NOT go back into recession and that the economy would grow 0.8 per cent over the year followed by 2 per cent growth in 2013 (see the chart below).

The real fear is that austerity will combine with relatively high inflation, both of which take money out of the pocket of consumers, and hold back the economy. This could degenerate into dreaded stagflation - no economic growth combined with inflation.

The OBR's official forecast for the economy - made in March 2012

So where did all this start?

IGNORE OFFICIAL STATS - CONSUMER DEBT IS STILL FIRMLY ON THE RISE

Official figures shows consumer debt falling marginally. But that doesn't take into account the amount simply written-off by banks, as repossessions and bankruptcies rise.

The campaign group Save Our Savers (SOS) points out that total consumer debt stood at £1,461bn in November 2008 and £1,452 billion in November 2011. But banks wrote off £26.7bn of consumer debt. So excluding the bank write-offs, debt actually rose by £18.4bn.

Credit card debt continues to 'run rampant', says SOS, rising from £53.3billion to £56.5billion over that time even thought an 'extraordinary' £13billion has been written off.

Total credit card debt when write-offs have been stripped out has exploded by £16.1bn.

So the clear picture is that debts are not only still rising but shifting across to financial companies. And that, if recent history is anything to go by, could one day become state debt.

And the projection, is that UK debt is set for another explosion. The Office of Budget Responsibility projects growth of  nearly 50% from £1.5trillion today to £2.12trillion by 2015.

Britain's 'Great Recession' started in the spring of 2008 and ended in the summer of 2009. This is based on the technical measure of 'recession' - see above.

The economy then raced out of recession faster than expected (see the charts above and below) but faltered again late in 2010, with the heavy snow of December blamed for much of it, and slowed to a snail's pace in the first half of 2011.

The Government's tax rises - VAT was hiked in January and income tax went up for the richer middle classes in April - have been made by austerity cuts are still kicking in.

The final negative factor - and possibly the biggest - is that consumers, companies and the state are all locked in a race to straighten out their finances.

That means each of these will spend less and try to pay down debts - a toxic combination for the economy in the short-term, although necessary for long-term health.

In reality spending has slowed but debts are still rising (see the box right)

The gloomy outlook was enough to persuade the Bank of England to start printing money again in October 2011. Its previous 'quantitative easing' programme saw £200bn 'created' for this purpose in 2009 and 2010.

In October, it said a further £75billion would be deployed, aimed at getting banks to increase lending - and more was added in February 2012. As we've long predicted, there's likely to be lots more QE as the economy limps along and deflation - falling prices - becomes a danger.

A concern stalking in the background, is 'stagflation'.

This [30-second guide] is where growth stalls but inflation remains dangerously high. The outcome can be disastrous: not only is real wealth eroded but it may mean hiking interest rates to control inflation, with the nasty side-effect of higher borrowing costs further damaging economic growth.

›› Also: How interest rates predictions have shifted

How this recovery compares with those of the past

The recovery in the economy follows the longest recession since British records began, with a 6.4% fall in output [More on how this recession compares with previous ones]. The full year of 2009 saw the economy shrink 4%(by the latest estimate) - the biggest calendar-year fall since 1921 [Why 1921 was such a bad year].

This chart from the National Institute of Economic and Social Research (June 2012) shows how the economy's progress since the start of the recession has actually been significantly worse than the four years after the Great Depression that began in 1930 (which, incidentally, was far milder in the UK than in the US).

This recovery from recession compared to those of the past: The current double-dip recession makes this a worst downturn than that of the Great Depression 1930s | Source: NIESR

The shape of the recovery

The shape of the recovery - if it continues - has been debated. The chances of a 'V-shaped' recovery have always been remote, despite odd spells of blind optimism. Among the other options are a 'W-shaped' recovery (right), as we explained in May 2009, or 'U-shaped' (long slump then recovery) or even 'L-shaped' (long-term slump with no recovery - like Japan over the past two decades which, for the record, I have long seen as the most likely prospect: Britain in 2020).

How big is Britain's debt problem?

At the start of the sovereign debt crisis, the UK was one of the worst offenders for over-spending. It had one of the worst budget deficit's in the EU in the last fiscal year (to April 2010), at more than 10% of GDP. It was beat only by Ireland (-32.4%) and Greece (-10.5%). Basically that means the British government spent more than it earned - to the tune of £146bn, according to the OBR.

While that overspend is being reduced, the UK's debts continue to grow.

Britain owed £1,022.5bn in March, a leap from £905bn a year earlier, according to the ONS [read the full release]. The government needs to borrow more than £127bn in the current year, lower than the £142.7bn the previous year.

Debt mountain: Despite the better performance in December, the level of debt as a proportion of GDP remains a daunting challenge for ministers.

That total debt figure, as the chart shows, already equates to 66 per cent of GDP (the total size of all economic output), up from 60 per cent a year earlier. And that 'net debt' figure does not even including bank bailouts and other 'financial interventions'.

With those included, the figure for the end of December was a whopping £2,305bn or 148.1 per cent of GDP, down slightly from 150.7% a year earlier.

Assuming the Government claws back its bank  'investments', Britain's 66 per cent debt measure is favourable compared to, say, Italy or Greece where it is more than 150 per cent or Japan at more than 200 per cent.

So no problem? Alas not. Because we're borrowing more than most other countries, we'll soon be climbing the total debt league tables and testing the nerve of investors. Any signs that we might struggle to repay then international markets would charge much higher rates of interest to lend, making it even harder to pay down debts. The Coalition's plans to tackle debts have so far been well received.

It also depends on how a country borrows money: Japan largely borrows from its own people - savers - rather than internationally [more on this]. But some economists regard a debt-to-GDP ratio of more than 90 per cent as the point of no return on the route to default and national bankruptcy.

The OBR forecast in April 2011 was for UK debt to peak at 71% of GDP in 2013-14.

There's also the not-so-small issue of Britain's household consumer debt problem which, in relative terms, is the second worst in the developed world. It is £1.5trillion and expected to grow to £2.2trillion by 2015 (see the box above). 

See these maps on The Economist website for a quick comparison of our debt problem vs others. The OECD also carries figures for public debt for euro zone countries.

Also, this 'ring of fire' chart published in 2010 by bond fund giant PIMCO perfectly captures the problem. Basically, you want to be in the top left corner. Being far to the right shows too much total debt and being too low down shows too much annual borrowing (debts growing too fast).

This graph below, published in March 2012 by Britain's Office for Budget Responsibility, is also worth digesting. It pretty much sums up why the OBR was created by the Coalition, showing how spending, as percentage of the economy, soared far higher than government earnings (tax) in recent years.

The darker line shows spending while the lighter line captures total income (tax)

›› How bad is Britain's state and consumer debt problem?

›› Could the UK face a Japan-style 'lost decade?

›› Greek debt crisis: Could it happen here?

›› Is Britain's economy really in recovery?

›› A sneak preview of Britain's wealth in 2020

Reasons for optimism

•  A weak pound made British products cheaper, helping exporters.
•  A powerful stock market rally boosted confidence [more].
• Unemployment rises have been smaller than forecast.
• Markets have welcomed Coalition efforts to tackle the deficit.

Reasons for pessimism

• The Government has embarked on savage public spending cuts that will dent demand.
• The QE impact is unknown. It could stoke inflation, forcing rate rises to control it.
• British house prices remain over-valued.
• Western governments and consumers have built up colossal debts that could take more than a decade to clear. A full explanation.
• Western economies face a demographic timebomb which could erode the wealth of nations for a generation. [A picture of Britain in 2020]
• Libor - lending rate between banks and a measure of confidence in each other - is elevated [Libor latest]
  

›› Charts that show how the recession hit

›› Why deflation could be our new nightmare

Who called it right? Predictions from the world's best experts:

Nouriel Roubini predicted the crisis back in 2006. He rightly warned again in January 2010 (more on this below) and several times in 2011 [More: Nouriel Roubini]

Billionaire speculator George Soros, who gave early warnings of the extent of the crisis, warned in October 2009 and Jan 2010 on imbalances and fresh asset bubbles. In October 2010, he warned it would be a currency war that would kill the global economic recovery and in September 2011 he claimed the U.S. was already in recession. [More: George Soros]

Nobel-winning economist Paul Krugman - wrongly - declared 'August 2010' as the probable trough for the recession. [Latest from Krugman - NYTimes.com]

Obviously all predictions should be taken with a pinch of salt. Correct forecasts get more coverage than failed ones. And even when experts have a good track record, there's no guarantee of a repeat. [There's more on this in our stock market predictions round-up]

All that said, it would be unwise to disregard the views of the world's most successful investors (more of which are included further below). 

Legendary investor Warren Buffett revealed he was buying shares in October 2008, at the worst stage of the banking crisis, but in July, he said more stimulus was needed. He said there were signs of life in the economy in April 2010. He showed his confidence with a massive share buyback in September 2011. [More: Warren Buffett]

Professor Nouriel Roubini, a US economist feted for forecasting the credit crunch as early as 2006, remained extremely gloomy about economic prospects in 2009, expecting American unemployment to rise to 11%.
- Roubini warns on 'sucker's rally'

...and in August he stepped up warnings of a double-dip. In October 2009, he warned the property market may yet undermine the recovery and warned again on the stock market rally.

A brief summary of the financial crisis:

Problems with the repayment of subprime mortgages in the US triggered a tidal wave of concern about lending around the world in August 2007. This was the beginning of the credit crunch, which can be measured with Libor.

British house prices began falling soon after and only stabilised in April onwards of 2009.

Northern Rock ran into trouble in September 2007 and was finally nationalised in February 2008.

In this first stage of the crisis consumers also felt a price squeeze: commodity prices rose rapidly in 2007 and the first six months of 2008, driven by demand from booming China and India, pushing up petrol, food and other basic costs. This surging inflation prevented central banks from cutting interest rates to help ease the credit crunch.

Fears increased with the collapse of Bear Stearns in March 2008 but the financial crisis proper began in September with the collapse of Lehman Brothers. That was followed in early October by a bank bailout and merger for Lloyds and HBOS. The UK base rate was also slashed (see below).

Despite all this, and bank bailout II in January 2009, recession was inevitable: US recession | UK recession.

How the 2009 Great Recession was fought

The initial reaction was for central banks to slash rates. In the UK, the bank rate was slashed from 5% in October 2008 to 0.5% by March 2009. It wasn't enough to ward off recession.

The Bank of England's new firepower was quantitative easing - increasing the supply of money in the UK economy. The Bank created money and bought assets (gilts) from financial companies. That made institutions more likely to buy other assets such as corporate bonds (that makes it cheaper for companies to borrow on bond markets) and shares in the form of rights issues (that makes it cheaper for companies to raise money on equity markets). It all combined to makes companies feel richer and less likely to sack workers. It was also meant to encourage banks to lend more: [a 30-second guide to quantitative easing | Why the BoE won't directly give you printed money - yet].

Various other measures were launched aimed at encouraging lending. A £37bn bailout was shared by RBS and HBOS-Lloyds in October. Other money was lent to banks or used for debt insurance schemes. A third bank bailout of £30bn - for RBS and Lloyds - came in November 2009. Estimates of the total taxpayer liability then, including lending and insurance schemes for banks, was put at nearly £1.5 trillion. The Government hopes to get its money back once the troubled banks return to health. If not, it will be paid for by higher future taxes.

The previous Government also throw money at the recession with other temporary measures such as a stamp duty cut and a VAT reduction. A £2,000 car scrappage scheme expired in April 2010.

See the latest impact on:
- Stock markets
- Bank shares
- The oil price | Oil price predictions
- Inflation
- Interest rates and predictions
- Gold prices

How to measure the credit crunch

- Libor is a rate at which banks lend to each other, serving as a measure of trust and of the credit crunch.

Pre-crisis, the three-month Libor rate was 0.10 to 0.20 higher than the bank rate but it soared in August 2007, marking the start of the credit crunch. It recovered over the summer of 2008 as some trust returned but spiked in September 2008. Bank bailouts, QE and economic recovery helped restore a more normal Libor-bank rate gap.

›› Latest Libor rate news and charts

MOST IMPORTANT READS:

2011
›› CHARTS: How the economic recovery came unstuck
›› Britain risks fresh recession, says OECD
›› UK borrowing less than expected in October
›› 70% risk of a double-dip recession, says NIESR
›› We've got another 3 years of this - Ken Clarke
›› New recession fear as UK economy crashes

2010
›› Why bulging Blumenthal Christmas pud sales are bad for Britain's wealth
›› What next for big global economies?
›› British economy: There's no need to panic
›› Economy view: Let's keep the bubbly on ice
›› Why the economy is facing a long road to recovery
›› Interview: The man who predicted the crisis on what to expect next
›› When will the good times return?
›› 2009 was worst year since 1921 - so why was 1921 so bad?

2009
›› The effects of quantitative easing: Q&A
›› Recession lipstick index latest: Make-up sales on the up
›› Real national debt is £2.2 trillion (not £805bn)
›› Why QE isn't working
›› Why inflation may be about to take off
›› The age groups most exposed to the slump
›› Will Bank cash splurge store up inflation?
›› UK economy bombed earlier and deeper - see the charts
›› OECD: UK debts largest in developed world
›› George Soros: Expect recovery and then stagnation
›› Alex Brummer: 'We're in depression territory'
›› How to solve the crisis, by Vince Cable
›› Why not give me some printed money?
›› How will deflation affect you?
›› Bank man: 'Rates could rise rapidly' Oxlade: 'Why it's unlikely'
›› Peter Oborne: 'Let's hope it's not a depression'
›› How baby boomers will dramatically extend the crisis
›› How to explain the credit crunch to your child
›› How the Big Bang killed traditional banking and led to a crisis
›› Is printing money the answer?
›› Bankrupt Britain: Could it happen? What would it mean?
›› What happens if all UK banks default?

2008
›› A recession map of Britain
›› Centre for Policy Studies: 'How to fight recession'
›› Keynes: Did he really help end the Depression?
›› A brief history of recession
›› How Gordon 'saved the world' | ...or was it Soros?
›› Dan Hyde: 'Is it 1929 again?'
›› George Soros: 'We're headed for a 1930s financial storm'
›› Credit crunch: 30-second guide
›› Michael Winner: How to survive the crunch