Financing conditions ease in North America

The financial crisis in the autumn of 2008 led to a significant increase in risk premia and this impacted quickly on investment through borrowing costs and equity prices, and hence to a very sharp slowdown in activity in the US. There has been a fiscal response in the wake of the Obama inauguration, but this will take time to feed through. Barrell, Fic and Holland (2009) estimated that the 2 per cent of GDP package in 2009 would add around 1.2 percentage points to output growth and the follow-on, worth 0.9 per cent of GDP in 2010, would add around 0.6 percentage points to GDP growth in that year. We expect the general government deficit to reach 14 per cent of GDP this year, albeit with an allowance for the cost of bank rescues, and we expect the debt stock to rise to more than 100 per cent of GDP within four years. The combination of very lax monetary policy with direct action to relieve pressure on banks has been at least as important in helping the stabilisation of output. Open market operations used to increase the money supply (often called Quantitative Easing) and the operation of the Troubled Asset Relief Programme, in combination with the Public Private Investment Programme, have led to significant falls in the cost of borrowing. Between June and September 2007 the spread between BAA corporate bond rates and government long-term interest rates, a good indicator of corporate borrowing costs in the US, rose by 200 basis points, and after the collapse of Lehman Brothers in September 2008 it rose another 300 basis points and stayed at this elevated level until April 2009. The BAA spread fell by 200 basis points between the middle of April 2009 and the middle of July 2009. Although this was partly offset by a 40 basis point increase in government long-term bond interest rates over the same period it meant the user cost of capital had begun to come down.