September brought the United Kingdom its first mass market bank run. Although there had been bank runs in the nineteenth century, with the last in 1866, very few people then had bank accounts so the runs were not in any sense comparable with what happened to Northern Rock, which showed a failure of mass retail banking.

Defaults on subprime mortgages in the US have triggered jitters in global financial markets over the course of this year, leading to a sharp rise in certain types of risk premia over the summer. The Federal Reserve and the ECB responded by injecting emergency liquidity into money markets, on top of which the Federal Reserve cut interest rates by 50 basis points in September. We expect the recent turbulence to be short-lived, and impacts on the real economy will be limited. We continue to expect global growth of 5.2 per cent this year, with a sharper slowdown in the US offset by persistently strong growth in China and a relatively robust outlook for Europe and Japan - despite disappointing outturns for the second quarter of 2007. Global growth is expected to ease to 4.7 per cent in 2008, reflecting more moderate growth in China and Europe. However, as annual global growth has exceeded 4.5 per cent in only nine years since 1970, global prospects continue to look promising. Risks to the outlook include a further rise in risk premia, which could potentially lead to major banking crises.

Over the summer of 2007 problems began to emerge in financial markets as a result of debt defaults, particularly on US housing lending to individuals with low credit ratings. The globalisation of financial markets has meant that such risks are shared across banks throughout the world and a number of European banks suffered major losses as a result of purchasing high yield high risk bundles of these assets. In this note we discuss the possibility of a systemic banking crisis as a result of debt defaults, putting this risk and its impact on the economy into recent historical context. We also look at the vulnerability of the personal and business sectors to increases in borrowing rates, and at the evidence for a risk related rise in borrowing rates. We then use our model, NiGEM, to investigate the impacts of a significant rise in the spread between lending and borrowing rates for both producers and consumers. Such an increase in spreads might arise when banks wish to rebuild their capital after a crisis or reflect significant capital rationing. In either case they represent the immediate impacts of a crisis in the banking sector. The spread between borrowing and lending rates for producers reflects a risk premium in the business sector, and was used in the September EFN report to the European Commission, whilst the spread between consumer lending and borrowing rates is in use for the first time on the model. The debt-to-income ratio has been rising in the personal sector in a number of countries, and especially in the UK, Ireland and Spain, as we can see from figure 1, and this might indicate where problems could arise.

GDP growth in the second quarter of this year remained robust at a quarterly rate of growth of 0.8 per cent. With revisions to previous quarters, economic growth has been maintained at this rate since the end of 2006. NIESR's monthly estimate of GDP showed this robust growth continuing into the third quarter of this year. The official preliminary estimate confirms the pattern of robust growth continuing into the third quarter of this year (figure 1). In light of this we have revised our forecast for GDP growth this year up from 2.8 per cent to 3.1 per cent. We have revised down our forecast for GDP growth in 2008 from 2.6 to 2.2 per cent. This reflects weaker net trade, with the recent financial turmoil having only a small domestic impact.

At the beginning of 2007 inflation was in excess of its upper threshold of 3 per cent and the Governor of the Bank of England had to write a letter to the Chancellor explaining why this had happened and what measures were to be taken to remedy this. It was our opinion that interest rates had been too low for eighteen months. It was also our opinion that the Bank had kept them too low because it anticipated wrongly that inflation would have accelerated if interest rates had been inappropriately set. In August 2005 the Bank of England cut interest rates by a quarter of a point, and held them at 4.5 per cent for around a year, before introducing five interest rate increases in the subsequent twelve months.

This paper examines compulsion in active labour market programmes (ALMP). When an unemployed worker has to participate in a programme in order to remain eligible for benefits there are two seperate effects. First, there is the treatment effect, i.e. the programme makes the worker more attractive for a potential employer or makes search more efficient, thus helping the unemployed worker to find a job more quickly. Second, there is the compulsion effect, i.e. because the worker has to attend the programme his value of being unemployed drops and he is stimulated to find a job more quickly. So, both effects induce the worker to find a job more quickly. The difference between the treatment effect and the compulsion effect concerns the quality of the post-unemployment job. The treatment effect improves the quality; the compulsion effect lowers the quality of post-unemployment jobs.

This article summarises the recent evaluation of Pathways to Work – a package of reforms aimed at encouraging employment among people claiming incapacity benefits (Belway et al., 2007). The results show an increase of over 7 percentage points in the probability of working about a year and a half after the start of claim. The probability of not claiming incapacity benefits was also increased initially but this effect later reduced to just 1½ percentage points. The findings suggest Pathways to Work may contribute to the Government's aim of increasing the employment rate. They provide less encouragement with regard to the aim of reducing by 1 million the number claiming incapacity benefits.

At present six million people are suffering from clinical depression or anxiety disorders, but only a quarter of them are in treatment. NICE Guidelines prescribe the offer of evidence-based psychological therapy, but they are not implemented, due to lack of therapists within the NHS. We therefore estimate the economic costs and benefits of providing psychological therapy to people not now in treatment. The cost to the governement would be fully covered by the savings in incapacity benefits and extra taxes that result from more people being able to work. On our estimates, the cost could be recovered within two years - and certainly within five. And the benefits to the whole economy are greater still. This is not because we expect the extra therapy to be targeted especially at people with problems about work. It is because the cost of the therapy is so small (£750 in total), the recovery rates are so high (50 per cent) and the cost of a person on IB is so large (£750 per month). These findings strongly reinforce the humanitatian case for implementing the NICE Guidelines. Current proposals for doing this would require some 8,000 extra psychological therapists withing the NHS over the six years.

Under the heading of flexicurity, Danish labour market activation policies are receiving international attention because of their perceived ability both to curb unemployment and to boost employment. Indeed, the objectives, target groups and design of activation policy have undergone a remarkable transformation over the past fifteen years. From the initial curbing of unemployment among the insured unemployed through standard activation offers, the aim today is also to increase labour supply among non-economic active groups using individually tailored programmes. Danish activation policies thus embrace not only active labour market policies but also social and integration policies. Despite widespread popularity and belief in the positive effects of activation, little is actually known about its overall impact on the Danish economy.