Your downturn questions answered

http://news.bbc.co.uk/go/rss/-/1/hi/business/7791775.stm

Version 0 of 1.

Peter Hahn is a specialist in corporate finance at Cass Business School

The state of the economy continues to be a source of interest and some confusion in the family home.

As the downturn continues to squeeze household finances, the BBC asked a group of academics to explain some of the basic principles of the UK economy.

We also asked readers to submit some of the general questions about the downturn that have been bugging them.

Here is a selection of those questions, answered by Peter Hahn - an expert in corporate finance, governance and banking issues at Cass Business School at City University in London.

<hr />

How does the Bank of England base rate affect the retail banks' rates? James Edwards, Sutton Coldfield.

The sad reality, is that the Bank of England base rate only has an indirect effect on banks' rates. Banks do not borrow from the Bank of England and lend on to consumers.

Banks principal source of funding is deposits and they must mark up the cost of these funds to consumers.

Lowering the Bank of England base rate creates a type of cascade through the system which will result in lower deposit rates but it takes some time - usually months.

Beware though, banks haven't made a lot of money in past years lending on money and now with higher expected losses they will be charging a higher margin above what they pay depositors. In many ways, this will negate the effect of base rate cuts.

I understand it is a problem, but exactly why can't a government just print more money in order to increase liquidity in the banking sector? Paul Pearson, Bristol.

The UK government can print more money either through the printing press at the Mint or through issuing government bonds. These funds can be used to stimulate the economy, or perhaps keep it from freefall.

Globally, deflation is the current theme and rates everywhere will move closer to zero <a class="" href="/1/hi/business/7767565.stm">Pub-talk economics questions answered</a>

It is not as easy to put such funds into the banks. Banks are required to have equity - shareholders funds in a small proportion - and deposits to fund their lending or liquidity provision. The government is helping out with both now.

Our problems are also largely due to banks running low on potential sources of cash from businesses and financial institutions, which funded the bulk of mortgage provision in recent years and much corporate lending.

In many ways, we are now expecting banks to keep pumping out their provision of liquidity and replace what the capital markets provided and that is not really possible.

Perhaps our biggest problem is capital markets illiquidity, particularly global, and this is sadly a very long-term fix.

Would actively searching out UK sourced products when shopping help the UK economy? In other words, would a "Buy British" campaign - as seen a good few years ago now - actually help our economy? Chris Lunn, Luton.

Buying British may be sound community spirit and have some environmental strengths but it is not the answer.

We import a good deal of our food and that won't change short of eating seaweed. The same goes for energy, but more importantly many more of our jobs than understood depend on foreigners buying British and if they did the same it would be 1933 all over again.

Globally, we're all in this together and hopefully we won't do anything stupid individually. It is a big political temptation everywhere.

How much do you think the BBC has created the "downturn" and should they be allowed to make forecasts or just report the news? Rich, Hereford.

A: Please don't shoot the messenger. I think the BBC can be, rarely, guilty of dramatising to make its point or get us interested in complex issues that are hard to see and some reporters have been accused of a little too much colour, but overall the BBC has done a superb job in breaking the news and keeping us informed.

Sadly, the BBC has sometimes shown up responsible officials who should have been further ahead of their game. That is more the problem than the BBC breaking the news.

How will the credit crunch affect an endowment which is due to complete in 2020? Prior to the credit crunch it was on track to payout in full? David Baxter, Washington.

It will probably look downright awful now and for the next few years but 2020 is very far away in financial terms. If we are still in this mess in 11 years your endowment will not be your biggest problem.

This has been a remarkably bad year for investments in general.

Unitised endowments are at the mercy of the markets and so another slump on the year the endowment matures could leave you short, whereas more traditional with-profits endowments in theory offer more of a cushion against sudden fluctuations.

The Bank of England Base rate has now fallen to a new low of 2%, with the possibility of it falling still further in the New Year. Do we have any idea just how long the base rate could remain at this level, or is it a completely unknown situation? Mark Simmons, Cardiff.

This is new ground. Globally, deflation is the current theme and rates everywhere will move closer to zero.

Rationally, this should encourage those with cash to see better returns investing their money in businesses and products and creating new growth.

That won't happen until greater comfort is established, particularly that we have flushed many of our excesses, or losses, out of the system. I think we'll get there in mid to late 2009.

Why do shares go up one day and down the next, surely someone is making a killing here? Joe Brooks, Warrington.

If you're a volatility player - say a day trader - you can make a killing or be killed in a nano-second.

This is dangerous ground and it doesn't appear many people are good or very lucky at it. However, the brokers who execute this business are doing pretty well for now.

Sorry, I can't recommend their shares.

What are the best and worst case scenarios respectively for the current economic crisis? Niall O'Kearney, Belfast.

The worst is too dreadful to contemplate - the world economy freezes and standards of living drop radically.

The best is that we learn from our mistakes and control the excesses that we have seen to create a more stable economy in the future. Though, this is likely to have slower growth than we've recently experienced and realised that we could not handle very well.

We generally do learn from our mistakes and perhaps this time the scale of the mistake will teach us enough for a generation.

Let's hope!

The opinions expressed are those of the author and are not held by the BBC unless specifically stated. The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.