Jean-Claude Trichet, European Central Bank (ECB) President

The late renowned American economist John Kenneth Galbraith recounted in his 1975 book, Money: Whence it came, where it went, how President Herbert Hoover startled a delegation of business and church leaders to the White House, in the grim summer of 1930. "Gentlemen, you've arrived 60 days too late," Hoover said. "The Depression is over!" Hoover had popularised the term "depression" for the economic crisis as the contemporary usage of "panic" or "bust" was simply too panicky. More than two decades later, President Harry Truman commented: "It's a recession when your neighbor loses his job; it's a depression when you lose yours."

The last bad recession (officially - two straight quarters of negative growth) experienced by the US was in 1981/82 when then Federal Reserve Chairman Paul Volcker battled to control inflation and won. In the past 25-years there have been various financial crises and recessions have been shorter and shallower.

This week's Economist (The turning point - available for general access at time of our posting) notes that much of the focus—in good times past, as well as bad times present—has been on America, where fluctuations in economic growth have fallen by around half since the early 1980s. In upswings the economy's growth rate has varied by less from one quarter of the year to the next and from year to year. Recessions have been rarer, shorter and shallower.

The most visible symptom of this smoother trajectory is in the jobs market. Since the mid-1980s, America's unemployment rate has fluctuated far less than it did in earlier generations. Between 1961 and 1983, America's annual unemployment rate varied from 3.5% to 9.7%. Since 1984, it has stayed within the tighter bounds of 4% to 7.5%.

Three important factors in the past quarter of a century have been:

• Improvements in managing stocks of goods - companies in effect holding much lower stocks and the decline of manufacturing in the modern economy

• Financial innovation that expanded credit markets and ;

• Better managed central bank monetary policy.

A study by Stephen Cecchetti, of Brandeis University, Alfonso Flores-Lagunes, of the University of Arizona, and Stefan Krause, of Emory University, found that 16 out of 25 OECD economies, including Britain, Germany, Spain and Australia and Ireland, had also seen a marked improvement in economic stability. The authors calculate that, on average, more than half the improvement in the stability of economic growth in the countries they studied is accounted for by diminished inventory cycles.

What will the outcome of the current credit markets crisis be? Will the European Central Bank cut short-term rates in 2008? Will the huge overhang of foreign holders of US dollar securities restrict the Fed from further big cuts in short term rates? Have not interest rates risen already in the US and Europe?

With the exception of the last, the honest answer to these questions is that nobody knows - yes nobody.

Fed Chairman Bernanke, former Goldman Sachs CEO and now US Treasury Secretary Hank Paulson, together with most of Wall Street, said that there would be no "contagion" from the subprime crisis and then on August 9th, it was bingo and a big surprise in the inter-bank markets. Who would have expected two weeks ago that Britain would see the first bank run since 1866? As central banks and regulators react to the subprime debacle and the packaging of mortgage risk for sale to parties who could not have a reliable measure of the risk, what will the impact be in housing markets in future, compared with where a Northern Bank could lend as much as three times per pound raised in the wholesale money market, than provided by its depositors?

The Fed responded to the optimists on Wall Street on Tuesday with a half-point cut in the Federal funds rate from 5.25% to 4.75%. However, long-term interest rates, which determine the costs of mortgages and other debt rose. Instead of falling with short-term rates, long-term Treasury yields rose for the week, with the 30-year T-bond ending Friday at 4.89%, up from 4.72% a week earlier. The US dollar fell by 1.5% amidst fears that inflation, propelled by rising oil and, food and beverage related commodity prices and the ebbing of the deflationary impact of the "China Effect," are being ignored.

A meeting of the Governing Council of the European Central Bank

On Thursday, in testimony before Congress, Fed Chairman Bernanke endorsed his predecessor Alan Greenspan's argument that persistently low long-term interest rates contributed to the boom, and that those rates had proved remarkably difficult for the central bank to control. Bernanke said: "I think there were other factors associated with housing price increases including very low long-term interest rates around the world, which were associated with big increases in house prices in other countries, not just the US." He said that when the Fed did begin to raise rates, those long-term rates failed to respond as much as they had expected. Greenspan said this week that inflationary pressures will rise as the disinflationary force of global integration ebbs and rising consumption in China and other emerging markets reduces the savings glut and pushes up long term interest rates.

Yale economist Robert Shiller says Fed and other central banks  do not have remedies like lithium or Prozac to counter the reversal of the psychology that fed property booms over the past 12 years.

In a speech in Germany on Friday at a seminar held in celebration of the golden jubilee of the Bundesbank, Fed Vice-Chairman Donald Kohn acknowledged that the Fed’s actions — through low interest rates early this decade — helped feed the start of the latest housing boom. But he says the housing market’s “worst excesses” came when short-term interest rates guided by the Fed were already higher, while longer-term rates stayed down due to other factors.

“I suspect that, when studies are done with cooler reflection, the causes of the swing in house prices will be seen as less a consequence of monetary policy and more a result of the emotions of excessive optimism followed by fear experienced every so often in the marketplace through the ages,” he said.

In the Irish Times on Friday, Alan McQuaid, chief economist at Bloxham Stockbrokers, wrote that lower ECB rates would give a timely fillip to consumer confidence, and quite easily lead to a recovery in the domestic property market next year. Apart from Robert Shiller's argument of psychology being an important factor in booms and busts - excessive optimism followed by too much pessimism - there are two issues to consider in relation to the European Central Bank.

Given that the current credit crunch is viewed as resulting from a period of "easy money," a fall back to the early December 2005 rate of 2% is highly unlikely. Secondly, given that risks to price stability are on the upside, short of a recession, the ECB is unlikely to cut rates to significantly impact the housing market, in the short-term.  

Interest rates have already risen in Europe.

Although a lot of focus will remain on the likelihood of the ECB cutting its current short-term key rate of 4%, There already has been another rate rise since June because of the credit crisis.

The 3 month inter-bank Euribor rate has risen by more than 0.5% since the ECB raised its key rate to 4% on June 6th last. In London, Libor rates have also jumped in the past month.

On Friday it was reported that the headline RBS/NTC Flash Eurozone Composite Output Index fell from 57.4 in August to 54.5, dropping for the third successive month to reach a two-year low. The month-on-month decline in the Index was the second-largest recorded since the survey began in July 1998 – exceeded only by that seen in the immediate aftermath of 9/11 in October 2001.

Ken Wattret, economist at BNP Paribas, told the FT that the composite purchasing managers’ index “has shifted from a level consistent with policy tightening to a level not far above that consistent with rate reductions in the past . . .we should be focusing on whether the next move in ECB interest rates is down, not up”.

Despite pressure from President Nicolas Sarkozy and Airbus (a rate of $1.45 would require €1 billion in extra savings) in respect of the impact of the high euro against the dollar, Lorenzo Bini Smaghi, ECB executive board member, emphasised in a speech in Paris on Friday that the central bank watched effective exchange rates, which take into account the relative importance of countries in trade and have moved less dramatically than the dollar-euro rate.

Regard should be given to ECB President Jean-Claude Trichet's record in standing up to French politicians when he headed the Banque de France coupled with the German Bundesbank orientation of the ECB.

At a dinner last Thursday evening to celebrate the 50th anniversary of the Bundesbank, Trichet said that the decisive condition, for the success of the Bundesbank has been the credibility it gained with the German people and with global financial markets. "Credibility is not something that can be installed by decree, it has to be earned," he said.

So short-term rate cuts may well come but would likely be in response to a recession in the United States. In that scenario, the optimists about the Irish housing market in 2008 like Alan McQuaid, would resemble the Wall Street herd on the subprime crisis, in the period Feb-Aug 2007.

Alan McQuaid revealed his frustration with other economists at the conclusion  of his Irish Times article. "I'm sick to death of people writing off the Irish economy and next year could easily see the "Celtic Tiger" roaring more loudly than many pessimists think," he wrote.

Writing off? or talking down? Maybe he was referring to Rossa White, his counterpart at Davy or David McWilliams?

Earlier in the week, Taoiseach Bertie Ahern dismissed some economists as people who know "nothing about nothing."

Questioned about the drop in house prices, Ahern said the market was "still in a good position", even if housing starts will fall next year to 75,000 from 95,000 this year (the total in 2006 was 93,000 and the 2007 out-turn will be lower).

"Thank God that they have come down a little bit. Last year we were talking about what chance the first-time buyer had. We were trying to get supply and demand in equilibrium. Thankfully, it is happening. I don't want house prices to go up," Ahern said but he was singing a different tune in 2006.

Ahern said in April 2006 that those who listened to negative commentators on the housing market, lost out in 2005 as prices continued to rise. It was simply all going to be grand!