Revision on the UK Economy AS and A

Revision on the UK Economy AS and A 2 Economics May 2009

Recession - causation • • • Global credit crisis Asset price deflation Rising food and oil prices Cuts in real disposable income Collapse of consumer and business sentiment De-globalisation Falling profits, investment Labour shedding Financial crisis has spread to the real economy Economics Blog

Recession Fallout

Recession Fallout – Key Points • Cyclical consequences – – Unemployment Rising budget deficit Falling business investment Inflationary pressures easing / wage cuts? • Possible semi-permanent effects – Rising structural unemployment – Other hysteresis effects including business failures – Changes to financial system – tougher regulation of banking and other financial services – Will the UK’s trend growth suffer? LRAS impact? Economics Blog

Policy Responses

Pulling every lever • • • Policy rates have moved to the floor (0. 5%) £ 75 bn quantitative easing (March 2009) 25% depreciation of sterling over last 12 months Injection of capital into the banking system Government borrowing of more than 12% of GDP (annual fiscal deficit > £ 175 bn) • National debt that > 80% of GDP within 2 years Economics Blog

Bank of England – From Independence to Impotence? 1. Nowhere to go on policy interest rates – liquidity trap reached? 2. Inflation target is being ignored for now (will there be a change? ) 3. The key rate now is on government bonds - not the base rate 4. Government committed to HUGE borrowing £ 175 bn in 2010 5. Will the Bank buy as many bonds as the government needs? Or will the bank say enough is enough? 6. For most people the base rate of interest is an irrelevance 1. Look at the cost of unsecured credit 2. Even if borrowing costs are low, can you actually get a loan? Economics Blog

Evaluation • Monetary and fiscal policy are now joined at the hip • Short term – appetite (demand) for bonds eases the problems of financing an eye-wateringly large fiscal deficit • Good fiscal stimuli are timely, targeted, and temporary • But there is no such thing as a free lunch • Fiscal policy will need to be tightened • There will be some crowding out of the private sector • We cannot ignore the risk of resurgent inflation in a recovery – whenever that comes • Weak sterling poses a major credit (solvency) risk for the UK government – even if we are not (quite) an Iceland Economics Blog

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