UK Economic Growth - interesting stats

Typically, the UK economy has grown at around 2.5%. In the last budget, trend growth was assumed to be 2.5% from 2010. In the UK, there have been periods of booms and busts; but, short lived recessions generally don't harm the underlying trend rate.










The recent OBR report on the UK economy suggests that the recent financial crisis / recession has led to a decrease in the UK's long run trend rate.

1. They have downgraded growth forecasts to 2.35% until 2013, and then fall back to 2.1%. For similar reasons, the OBR has cut the estimate of the amount of spare capacity in the economy at the end of 2009 - from 4% of GDP to 2% of GDP.
   
   A lower average growth rate (long run trend rate) means the economy will expand at a slower rate. It means tax receipts will grow slower than expected, making it more difficult to reduce budget deficit.
   
   If the data about spare capacity is correct, it means demand pull inflationary pressures may return sooner than expected.
   
   A prolonged recession has the capacity to reduce long run trend rate of growth because:
   
   Rise in unemployment can lead to loss of skills, people becoming demotivated, leaving labour market early (e.g. going on disability benefits)
   


2. The recession highlighted the flimsy nature of a consumer led (asset price) driven growth.
   


3. Financial sector has taken a hit
   


4. Banks become more cautious in lending, making finance more difficult.
   


5. Change in attitude by consumers and firms.

The good news about the OBR report is that borrowing is likely to be £25bn lower than expected. The bad news is that there is still a substantial structural deficit. But, markets are likely to be reassured that the UK doesn't have any budgetary black holes, and there is a reasonable path to fiscal stability.

The bad news about the report is that growth forecasts of 2.25% don't really take into account;

prospect of spending cuts
prospect of European wide slowdown, from Euro austerity packages.
If there is a strong external shock combined with tightening of fiscal policy (and politicians repeating how bad the economy is) growth may fail to materialise and we will struggle to reduce unemployment and tackle deficit.

However,

Growth forecasts for 3-4 years in future are notoriously difficult to predict. Given volatility in the world, a lot can change.

If we are willing to turn a blind eye to inflation, then loose monetary policy may be sufficient to offset the deflationary impact of fiscal policy.

It may also be too early to judge about the long run trend rate of growth. Technological factors may still enable 2.5% growth.

UK fiscal deficit (compare with Canada's solution)

Good article on fiscal policy.....hope you find it interesting!

It seems the whole of Europe has developed a mania for good old austerity, and deficit cutting. (One could almost forget we have 2.5 million unemployed, it seems the only economic objective in Conservative Britain is reducing the budget deficit.)

Mr Cameron has been holding up the example of Canada as a good example of a country who radically cut spending in the 1990s. It is easy to take a historical precedent and give misleading impressions we can apply it in different circumstances.

A few features of Canadian deficit reduction of the 1990s:

Canada debt wasn't at crisis levels, it was half that of Italy and Belgium

The Spending Cuts were offset by a loosening of monetary policy. Canadian interest rates were cut to maintain consumer spending (UK rates cannot be cut, only more quantitative easing.)

The Spending cuts were also offset by a strong depreciation in the Canadian currency and a boom in exports to the US. At the time the US were growing strongly. In 1998, Canadian exports accounted for a staggering 45% of GDP.

An Example of A Fall in Government Borrowing Leading to A Rise In Private Borrowing.




The fall in government borrowing was offset by a rise in private and corporate borrowing.

What people forget is that in a recession government borrowing needs to rise to offset the rise in private sector saving.

Focusing only on government borrowing gives a misleading impression to the indebtedness of a county. See: Principles of Borrowing which offers a similar graph for US.

Government borrowing in a recession should not be seen as 'reckless' or 'irresponsible'. The only irresponsible action is to starve the economy of spending at a time when it needs it most. It's a lesson we've trying to learn ever since the Great depression

Why UK spending Cuts would not Work like in Canada

There is little room for monetary policy easing.

There is little scope for further export led growth. The Pound is depreciating, but many countries are now trying to allow currency to weaken.

Austerity in Europe is creating less growth in the Eurozone - our main trading partner.

Household sector is still fragile, tax rises and spending cuts would lead to a fall in private sector spending.

Lower growth will make it difficult to reduce the deficit.

Deflation...Again!!

Yes I know I have been banging on about deflation in the past, but it is just as bad if not worse than inflation. So take time out to have a read of following....again;

Despite the UK having inflation of 3.7%, deflation is a potential problem around the world. For example, in April of this year:

US core consumer prices rose by a mere 0.9% - lowest rate for many years

In the euro area they rose by 0.7%.

In Japan, which has battled falling prices for more than a decade, they fell by 1.5%. (Japan now has the same Nominal GDP now as in 1992)

It may seem good when prices fall, but generally falling prices is bad for the economy. The only real exception is when falling prices are due to rising productivity and technological innovation. (ie Aggregare Supply shifts)

This is why.

When prices are falling, consumers tend to delay purchasing. Rather than buy a flatscreen today, they wait a year when they will be cheaper. The effect of falling prices is to depress consumer spending leading to lower economic growth.

Increasing real value of debt. When people take on debt like mortgages, they expect the value of the debt to be steadily eroded by inflation. (A mortgage becomes easier to repay as your wage increases). When there is deflation, the real value of debts increases. You owe the same, but, your wage is falling. Therefore, you have to spend a higher % of your income on servicing the debt

Increasing Government Debt to GDP ratio. Deflation also increases the real value of government debt. It makes it much more difficult to reduce the debt to GDP ratio. Thus countries can start spending a higher % of income on debt repayment. Furthermore, as deflation tend to reduce economic growth, the cyclical deficit increases. This lack of nominal GDP growth is a key factor in why markets dislike the Greek situation.

Real Wage Unemployment. Wages are often sticky downwards. (Unions resist nominal wage cuts). Therefore, falling prices are often not met by falling wages, leading to a rise in real wages. This creates real wage unemployment. It also makes a countries exports less competitive (particularly a problem in the Eurozone where countries can't devalue the exchange rate)

Monetary Policy Becomes ineffective. With deflation, zero interest rates may be too high. Even quantitative easing may be insufficient to get people spending. (deflation and monetary policy)

Year 10 - Economics

Market systems.....

Benefits of Globalisation

This was a bit more difficult to find, which suggests to me that perhaps the impact of globalisation is seen as more negative than positive.....

Disadvantages of Globalisation

Advantages to follow.....

Exchange Rates - A Run on the pound??

A run on the pound refers to a situation where international investors become nervous over holding sterling and sterling assets, and so sell as quickly as possible.

A run on the pound may occur when markets feel the Pound is overvalued and likely to fall quickly. If markets expect the pound to fall, they will sell quickly before making a loss.

What May Cause a Run on the Pound?

A run on the pound is more likely in a semi fixed exchange rate. e.g. when the Government is committed to trying to keep the Pound at a certain level.

If markets feel this level is unsustainable they may keep selling Pounds until the government is forced to devalue.

For example, in 1992, the UK tried to maintain value of Sterling in ERM, but, ultimately markets forced the UK out and we had to devalue (black Wednesday!).

We also had a run on the pound in the late 60s, causing the Wilson government to devalue pound. (In 1967, Wilson devalued pound by 15% after selling many foreign currency reserves trying to maintain value of Pound)

http://www.youtube.com/watch?v=TR8Esy-QMdA

In 1976 there was another run on the Pound as markets feared the UK's fiscal position.

High Inflation

High inflation reduces the value of Pound Sterling. Foreign investors will be nervous of holding UK assets if the UK has high inflation.

Is the UK at risk from a Run on the Pound?

At the moment, we aren't. Firstly the Pound is floating i.e. governments are not trying to keep its value high. The Pound has already depreciated by about 20% in past 18 months. - This wouldn't count as a run on the pound but large gradual depreciation. With a floating exchange rate, there is less chance of markets feeling an exchange rate is fundamentally overvalued.

UK's debt is a concern, but, we still retain AAA rating and prospects for growth have improved situation. It certainly looks worse in some other European countries.

Would Membership of Euro protect against A Run on the Pound?

Well, we couldn't have a run on the Pound, but, it doesn't solve the underlying problems like lack of competitiveness, excessive government borrowing, negative growth. Being outside the Euro, would give Greece more flexibility for dealing with their crisis.