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Revision on the UK Economy

Revision on the UK Economy. AS and A2 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

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Revision on the UK Economy

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  1. Revision on the UK Economy AS and A2 Economics May 2009

  2. 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

  3. Recession Fallout

  4. 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?

  5. Policy Responses

  6. Pulling every lever • Policy rates have moved to the floor (0.5%) • £75bn 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 > £175bn) • National debt that > 80% of GDP within 2 years

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

  8. 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

  9. For essential last minute revision on Economics, don’t forget to visit the Economics Blog everyday

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