2008 was a year of shock and awe for the world economy
Tue, Dec 23 2008, 06:43 GMT
by Lloyds TSB Financial Markets Economic Research Team
next reprot is published on 12 january 2009
2008 has been a year full of tumultuous events for financial markets, with the failure of some of the brightest names in the banking sector and wholesale government rescues being mounted for most of the rest. Low financial market volatility, a feature of the last seven years, turned into one of the highest periods of volatility ever experienced in some markets. The boom in the world economy has come to an abrupt end and now seems a distant memory. But at the start of the year, there was some optimism that while economic growth would slow, outright recession would be avoided. Now, the world economy faces the worst recession since the 1980s. Inflation was not seen as a major problem at the start of 2008, but by the end of the year deflation and disinflation were the main concern.Economic forecasts for 2008 were almost uniformly wrong…
Consensus forecasts show that expectations for economic growth in 2008, made in December 2007, were way too optimistic. Chart a illustrates that the latest (December 2008) projection for growth this year has turned out to be sharply lower for every country included. Such was the growth momentum at the start of 2008, however, that although all of the countries in the chart are now in recession, none of them will see an outright fall in gdp this year; that will come in 2009, when all of them will see a fall in output. For the UK, economic growth is on course to turn out less than half what was the expected increase. For Japan, economic growth will turn out to be two-thirds less than predicted at the start of the year.
…economic growth, inflation, interest rates were all thrown off course…
This deterioration in the growth performance is occurring despite lower short term and long term interest rates in all of the major economies than was expected at the start of 2008. Charts c and d highlight how much interest rates, short and long term, have collapsed. But short term rates are measured using interbank quotes, and these are much higher than official benchmark lending rates due, of course, to the ongoing credit crisis. If short term rates are analysed in terms of official levels, they are in most cases at or below historic lows, because these economies were at the epicentre of the credit crisis, except Japan whose banking sector has not been as badly hit by it directly.
Despite weaker economic growth, consumer price inflation has turned out higher than forecast, see chart b. Indeed, consumer price inflation has been higher in all of the economies projected than was expected, as economic growth in the first half of 2008 turned into outright declines in output in the second half. This is testament to the ferocity of the turnaround that has occurred in the global economy in 2008 ending, in the case of the UK, 16 years of uninterrupted growth and one of the longest and strongest expansions in the world economy since the Second World War. Oil and commodity prices played a decisive role in pushing up inflation, so reducing real incomes and hence hitting economic growth. For instance, oil prices rose to a peak of $147 a barrel in July before subsiding to around $35 at present. As a result, the economic forecasting record was not great last year for anyone, but then the demise of famous companies that had survived for hundreds of years and the effective failure of the global financial system does not occur too often either.
…because of one of the worst ever financial market crisis…
The year started with fears that the credit market crisis, which had begun in Q3 2007, could spill over into price deflation and economic crisis. However, chart e shows that credit market and stock market risk perceptions, as measured by the Vix volatility index, were stable, albeit at a much higher level than in the previous 5-7 year period. But in the second half of the year with the bankruptcy of Lehman Brothers (a 150 year old firm), the rescue of all of the top US investment banks and a host of other financial market companies, as Fannie Mae and Freddy Mac also went into explicit public ownership, confidence went into a nosedive. This is shown in charts f and g, where stock markets crashed lower and the dollar fell sharply against some currencies but gained against most others. However looked at, 2008 was as fundamentally a defining moment in economic and financial markets history as any in previous generations, and it is not yet over as we enter 2009. Many of the issues and challenges posed in 2008 are persisting into 2009 - with some sort of resolution possible for some of them, one way or another - but not necessarily for all of them.
