The country is displaying early symptoms of being trapped in a so-called “debt deflation trap” where families find themselves pushed further and further into the red every month, according to a Bank report published today.
The stark warning will cause serious concerns, since it was this combination of falling prices and soaring debt burdens that plagued the US in the 1930s.
The Bank is using its Quarterly Bulletin to highlight the threat posed to the economy by deflation – where prices fall each year rather than rise.
Although inflation is currently in positive territory, it is expected to become negative in the coming months.
The Bank is worried that this may combine with high levels of indebtedness to squeeze families further.
It says that families with high debts could fall prey to the debt deflation trap. This means that the cost of their debts, which are fixed, would rise compared to average prices throughout the economy. While inflation erodes debts, deflation makes them relatively higher.
The Bank’s paper suggests that Britain is particularly at risk because there is a high proportion of families with significant levels of debt, and many of them are on fixed mortgage rate, which means they will not benefit from rate cuts.
Britons’ total personal debt – the amount owed on mortgages, loans and credit cards – is, at £1.46 trillion, more than the value of what the country produces in a year.
Total personal debt has risen by 165 per cent since 1997 and each household now owes an average of about £60,000.
The Conservatives claim this is the highest personal debt level in the world.
The Bank’s paper also says that consumers were suffering as banks keep the cost of borrowing high, despite Government attempts to get them lending again.
Alistair Darling, the Chancellor, and fellow finance ministers used their pre-G20 meeting this weekend to warn that more drastic action was necessary to help bring the world economy back from the brink of a possible repeat of the 1930s.
The Bank’s report puts pressure on Gordon Brown, who this weekend faced further calls to apologise for the recession, to secure agreement on an effective international rescue strategy when he hosts the G20 leaders at a summit in London at the start of April.
It comes as figures this week are expected to show the number of people unemployed will reach the two million mark.
The Bank’s report says: “This configuration of falling asset prices and depressed economic conditions in the face of an adverse demand shock is consistent with recent and prospective macroeconomic developments in the United Kingdom and internationally”.
It helps explain why it took such dramatic action earlier this month to pump extra cash into the economy.
The bank slashed interest rates to just above zero and pledged to create £150 billion worth of cash with which to buy up government and corporate debt.
This so-called quantitative easing is regarded as a radical measure to help prevent a repeat of the conditions associated with the Great Depression.
Many experts believe that the US authorities’ initial reluctance in the 1930s even to cut interest rates was partly responsible for causing the worst economic slump in Western history.
The Chancellor acknowledged at the G20 meeting that the economic situation was “grave” but pledged not to allow a repeat of the Depression years. The ministers promised to pump more cash into their economies if necessary in the next few months.
However, some have expressed concern that the meeting failed in its aspiration to reach a specific agreement on the amount of cash countries need to spend in the coming year. Others have warned that it does not set a clear enough agenda for the much-anticipated full G20 summit on April 2.
Some speculate that the Prime Minister may use the G20 as a justification for a series of further tax cuts and spending increases in the Budget next month, though many economists have warned that despite the scale of the recession faced by the UK the Treasury has little capacity to borrow more.
Mr Darling has signalled that the meeting must not be allowed to mirror a 1933 summit in London which failed to halt the Great Depression. He said failure to agree co-ordinated action then meant that the Depression continued for years when it “need not have done so”.
Writing in The Sunday Telegraph George Osborne, the Shadow Chancellor, said Mr Brown must use the G20 as “the moment to send the clearest of signals that, unlike in the 1930s, this banking crisis will not send the world spinning into a protectionist spiral.”
He said that “ministerial promises” had failed to deliver any real benefits to struggling home owners or desperate businesses.
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