Recession in the UK and the Economic Condition - Case Study Example

Is the UK economy out of recession? The worldwide recession precipitated by the financial crisis in the United s has had disastrous consequencesfor the UK economy as well. This most recent episode of recession in the UK happens to be the worst it had faced in the period following the Second World War. Based on the GDP numbers for the years 2008 and 2009, one learns that “the economy contracted even more sharply than previously thought in the first quarter of 2009: 2.4 per cent compared to the preliminary estimate of a 1.9 per cent contraction.” (Lynch, 2009) The promising rise of industrial production in April last year did provide hope for an early recovery. But this hope was to prove a mirage as the trend reversed in subsequent months. Though the UK took a little while to catch up with the crisis in the United States, at the beginning of the second quarter of 2008, the region’s economy was in acute recession. It has been close to two years since the onset of recession in the UK and the economic condition of the region remains weak and vulnerable. While some economists assert that the turnaround is already underway, others take a more pessimistic view. This essay will try to answer this important question, by way of perusing scholarly and news media resources. (Lynch, 2009) The recession that began in early 2008 gave no signs of recovery even after one full year. As the industry data for third quarter 2009 revealed, the economy shrank a further 0.4 % in during this period, which completed the sixth consecutive quarter in decline. As per the Office for National Statistics, by this time “output has slumped 5.9% since the onset of recession - almost as bad as the 6% slump seen in the early 1980s. The lingering decline came despite interest rates at a record low of 0.5% since March, additional Government spending and an unprecedented pounds 175 billion boost to the money supply through quantitative easing” (Lynch, 2009). But even as the UK was enduring this economic decline, neighbouring countries such as France and Germany have already shown early signs of recovery. While neighbouring countries in Europe were already into recovery, it was only during the heralding of year 2010 that the UK economy showed clear signs of recovery. Financial experts have declared that technically the UK economy has emerged from recession, but concerns still remain about the stability and strength of the pound against the dollar and the euro. Due to the internal economic turmoil, there is a strong possibility for deflation of currency during this period of recovery. So while the UK is technically out of recession for the last three months, there are concerns in the short term including the following: "Even accounting for a dent to potential output from the recession, the output gap is probably already over 3% of GDP and is unlikely to be closed until 2015 or so, which is both disappointing and concerning. The worse than expected figure could signal a downgrade to official growth forecasts in Novembers Pre-Budget Report, which would mean public borrowing rises beyond the record pounds 175 billion estimated.” (Alistair Darling, 2009) In this scenario, even after a few quarters of recovery, the economy will be fragile and volatile. The financial year 2010 will be a difficult one for other reasons as well. For example, the stimulus measures undertaken in the wake of the economic crisis such as the temporary value-added-tax cut, the ‘cash-for-bangers’ exchange scheme, etc will be rolled back soon. Added to this the persisting unemployment problem is likely to continue this year as well. The prospect for a quick recovery is undermined by the weakened fiscal balance position during this recession. This weakening is not completely due to the fiscal stimulus packages undertaken in 2008 and 2009, since the fiscal deterioration caused by it is quite small. “Removing the impact of the fiscal stimulus still leaves deterioration in the public finances almost twice that of each of the two previous recessions, and does not reflect normal cyclical patterns. Some of the deterioration in the public finances is due to the collapse in tax revenues from the housing and financial intermediation sector. The Treasury expects receipts from these two sectors to decline by around 1 1/2 per cent of GDP over this fiscal year and next.” (Kirby & Barrell, 2009) The financial markets are concerned about this situation. The weakening of the pound against the dollar and the euro on the back of weak growth prospects is also a worry. Gilt futures rose sharply as a consequence, which meant that agents and dealers would end up with lower yields. Results such as these show that even as the recession is technically a thing of the past it would be imprudent to rollback stimulus measures. Rolling back stimulus in the form of cutting down public expenditures might actually lead to a double-dip recession. (Kirby & Barrell, 2009) Further, as consumer demand fell sharply with the onset of the recession, the manufacturing industries have developed excess production capacity. This spare capacity is set to grow further due to modest consumer demand expectations in the coming year. Moreover, measuring the level of spare capacity will be a tough task until detailed statistics is obtained about the “level of scarring to output in the longer term”. In this scenario, analysts expect inflation to be kept under control. Research team headed by S. Kirby, who bases his forecasts for the UK economy on historical trends and empirical data, has the following to say: “Given the recent Bank of England forecasts, the Monetary Policy Committee (MPC) undoubtedly shared this view when they extended the Asset Purchase Facility (APF) by a further 50 billion [pounds sterling] to 175 billion [pounds sterling] at their August meeting. A weaker recovery than we expect could warrant further extensions. We continue to hold the view that any further extensions should be biased towards the purchase of corporate paper, rather than the purchase of government debt in order to reduce financial stress in the business sector. Underlying our forecast for the economy is the assumption that changes to Bank Rate follows the yield curve.” (Kirby et. Al., 2009) As per this assessment, the Bank Rate is expected to remain the same for at least another year. After that, it is likely to be raised incrementally, implying that the expansionary monetary policy framework of the New Labour government will continue its course till the next parliamentary elections at least. There is also the possibility of lower Bank Rate if and when future fiscal plans impose a sharper tightening of the public finances, thereby posing a threat to growth prospects in the short term. (The Daily Mail, 2009) One of the first signs that the economy was on the path to recovery was the fall in unemployment figures for the first time in two years. The other crucial indicator was the slight growth in manufacturing sector. BBC’s chief economic correspondent Hugh Pym noted early this year that the manufacturing and service sectors in the UK grew by 0.1% in the last quarter (The Journal, 2009). Though this figure is only a tentative estimate and could either be revised higher or lower. But either way, there is not going to be significant shifts statistically, reinforcing the fact that the economy is still functioning way below both its pre-recession and trend levels of output. In this scenario, renowned economists such as Stephanie Flanders of the BBC have listed the key factors determining recovery while also warning about a prolonged recovery period. Firstly, in order to consolidate the recovery it is crucial that the government take steps to encourage consumer confidence and demand for consumption. To achieve this, keeping interest rates stable is the key as it would ensure sustainable recovery. Another time-tested method for consolidating the growth trend would be to drive-up exports. (The Daily Mail, 2009) Some economists believe that the recovery (however mild it might be) was made possible by the support provided by Bank of England through its low interest rate policy. In other words, “analysts think the economy has only returned to growth at all because of the extraordinary support from the Bank of England in the form of ultra-low interest rates and £200bn of "quantitative easing", as well as the government allowing the budget deficit to expand hugely. If that support is removed too early, some argue, the economy could struggle to grow strongly. Most analysts are only expecting the economy to grow by around 1% this year, compared with its long-run annual average of 2.5%. The recent retail sales numbers have disappointed, as has consumer confidence, while consumer fundamentals remain very poor. Indeed, household indebtedness remains at very high levels and household incomes are under downward pressure from a weak labour market and higher taxes." (Kirby & Barrell, 2009) Statistics released by the British Bankers Association “shows another net repayment of consumer debt in December, especially of overdrafts and personal loans” (The Journal, 2009). This was obviously due to the result of many factors, including consumers desire to alleviate their debt, low credit demand and the non-availability of unsecured credit from banks. This shows that consumers are trying to improve their financial situation in what is largely a worrying economic climate. Further, the fiscal deficit in the UK is predicted to reach the 14% mark, which is nearly double the average deficit level in other major economies of the world. According to a report released by the Organisation for Economic Co-operation and Development (OECD) public finances have declined significantly since the beginning of the recession and this makes it imperative that the UK continues to develop a more robust economic policy framework for reducing the ratio of debt to output. Toward this end, the government should devise a fool-proof and comprehensive plan of action to make sure that debt levels decrease once recovery starts consolidating. Moreover, according to analyst Kelly Macnamara, “UK unemployment, which currently stands at a 12-year high of more than 2.2m, will "rise substantially" and "labour market conditions will remain unfavourable for a long period". While labour market flexibility remains relatively high in the United Kingdom, policies to help the unemployed remain employable should remain a priority," it said. The OECD said the rate of unemployment is expected to grow to 9.7% in 2010, double that seen just five years before, although this is still lower than other countries. Spain is set to see the worst level of unemployment, at 19.6%, while the US level is predicted to rise to 10.1%.” (The Journal, 2009) The results for the first few months of this year have showed promise for the corporate sector as well. For example, investment banks in the UK are making profits again triggered by the impressive US non-farm payrolls. But overall, business leaders here in the UK and rest of the world remain pessimistic about substantial turnaround in the near future. Further, institutions such as the International Monetary Fund present a more conservative estimate of future recovery. Taking into consideration the interconnectedness and intricacies of the global economic system, the IMF states that while there are some positive signs emerging from economies of the G20 bloc, the overall confidence in financial markets remains weak. Business corporations too are feeling the adverse effects of credit crunch. To make matters worse, banks are enforcing more stringent norms on corporate revolving loans. (Hawser, 2009) While the Gordon Brown government takes measures to get the economy back on track, it is equally important for enacting of legislations that would prevent recessions in the future. This view is supported by major corporations, banks and pension funds as well. A careful survey conducted by Greenwich Associates reports “surprisingly strong support for regulatory proposals such as the establishment of so-called ‘systemic regulators’ and the mandatory separation of investment and commercial banking operations, as well as tightening of regulation of hedge funds and greater oversight of derivatives” (Hawser, 2009). This consensus needs to be looked into, for otherwise all policy measures would only fetch immediate relief and no lasting economic stability. In sum, what is needed to prevent recessions in the future is a new model of economic growth “that includes a credible deficit reduction plan that keeps mortgage rates low, creates jobs and doesnt choke off recovery." (Hawser, 2009) References: Hawser, A. (2009, September). When Will Recovery Come?. Global Finance, 23, 6. Kirby, S., & Barrell, R. (2009). Prospects for the UK Economy. National Institute Economic Review, (209), 42+. Kirby, S., Barrell, R., & Foley-Fisher, N. (2009). Prospects for the UK Economy. National Institute Economic Review, (210), 39+. Longest-Ever UK Recession, (2009, October 24). Daily Post (Liverpool, England), p. 17. Lynch, Russell, Recession over, but a Steep Climb Ahead; Economy Hopes Could All Unravel Again in 2010. (2009, November 18). The Daily Mail (London, England), p. 17. Recession UK Left Behind by Europe. (2009, November 14). The Daily Mail (London, England), p. 2. Macnamara, Kelly, UK Budget Deficit to Be Worlds Worst Only a Mild Recovery in 2010 - Report. (2009, June 25). The Journal (Newcastle, England), p. 18. UK Recovery Hopes Grow as Pain Eases. (2009, July 14). The Evening Standard (London, England), p. 33. Read More