Over 2012/13, to what extent was the output gap a cause for concern - Essay Example

When the financial crisis of 2008 hit the world, United Kingdom was no less immune to a financial hit. The UK economy was hit with reduced output as the money-lending markets were struck badly and unemployment increased at a very quick rate. As a matter of fact, the Gross Domestic Product growth rate of United Kingdom entered the negative figures zone as is illustrated in the chart below. It can be seen in Figure 1 that the GDP growth rates have been showing a poor reading including in the financial year 2012/13.

However when it comes to the potential GDP of United Kingdom, the pre-financial crisis years were prosperous for the economy when it experienced high GDP growth rates, increasing employment rates, higher government spending, and greater investment. Therefore the potential output was based upon the data of the pre-financial crisis due to the fact that it represents that the UK economy has the potential to prosper when run efficiently. In Figure 2 on the right, it shows that year 2007 has been considered the base year for potential output at 100 points building upon the trends since the year 2003.

Based on this data, the output gap has reached a massive 9 base points which is certainly not desirable for the UK financial authorities. This huge output gap can have some major and devastating impacts on the UK economy. The increasing output gap means that the actual economy is not progressing as well as it could have when running efficiently. Investments were a major source in the development of UK economy but due to the financial crisis, the money-lending organizations have adopted a very prudent approach to giving loans.

Since the loan market is now not as broad as it previously was, the investors have shown hesitancy in investing their money in the United Kingdom. This can have long-term damages to the economy since investments lead to increased employment and more tax revenues for the government which in turn contributes to the economic growth. The consumer spending has consistently been very low in UK which has continued in the financial year 2012/13 currently standing at 229000 units (Trading Economics, 2013).

Since the consumer spending is usually the most significant contributor to the Gross Domestic Product, the economy has suffered with below-par economic growth rates. Figure 3 shows the output gap as a percentage of the potential GDP which is estimates to have increased in 2012/13 which either reinforces that the output gap has increased or the potential output of UK economy has been revised to be at a lower level. When the output gap rises, this means that the investor confidence in the economy is decreasing since it a signal that the economy is not performing what it actually should given its potential, and that inefficiencies exist in the economy and hence the output gap.

This investor confidence requires a lot of time to win back and the UK government and finance authorities should take an action sooner rather than later before it turns out that the potential of the economy has decreased which will be an even bigger dent to the economic aims and objectives. To win back this confidence, the United Kingdom government has already started to take actions which have been quite the opposite of what the other developed nations are doing. Most of the nations who were hit badly with this financial crisis have adopted austerity policies of cutting the government expenditure.

It initially was also