Current Financial and Economic Situation in the UK - Statistics Project Example

Why has the UK Economy been so Successful over the Past 20 Years? Table of Contents I. Introduction ……………………………………………………………….. 3 II. Fiscal Policy behind the UK Economy …………………………………. 5 a. Employment and Unemployment Rate…………………….. 5 b. Gross Domestic Product (GDP) …………………………….. 9 c. Effectiveness of the Fiscal Policy used in Addressing the UK Economic Problems……………………. 10 III. Monetary Policy in UK……………………………………………………… 15 a. Inflation Rate ……………………………………………………. 15 b. Interest Rate ……………………………………………………. 19 c. Exchange Rate…………………………………………………. 20 d. Effectiveness of the Monetary Policy Used in Addressing UK Economic Problems………………………… 22 IV. Techniques Used in Collecting Important Data ……………………….. 24 V. Evaluation of Research Findings, Arguments, and Date Collected …... 24 VI. Conclusion …………………………………………………………………. 26 References ……………………………………………………………………… 26 - 29 Introduction As a result of the slow economic growth during the late 1980s, the United Kingdom experienced the worst UK economic recession under the leadership of former Prime Minister Margret Thatcher back in 1992. Nigel Lawson was the UK chancellor between the years 1983 to 1989. Under the Thatcher legacy, some people claimed that one of the key factors that had significantly contributed to 1992 UK economic recession was the global economic recession whereas others pointed the blame on Lawson for failing to recognize the full implications of implementing financial de-regulation on most of its state-owned enterprises within the industrial and service sectors (BBC One, 2008). A decade after the “Thatcher’s economic miracle” (BBC One, 2008), the United Kingdom is considered as one of the most advanced and developed country around the world. As of December 2007, the United Kingdom stands the 5th largest in the world market in terms of its exchange rate and the 3rd in terms of its purchasing power parity (PPP) (Finfacts Team, 2007). Despite being one of the world’s strongest countries in the world economy, the British government made a confirmation that the UK economy is in recession because of the recent global financial crisis (BBC News, 2009a). Although the United Kingdom has been capable of maintaining a low level of inflation, interest, and unemployement rates for many years; the trend behind these economic indicators show signs of increase since the first quarter of year 2008 (BBC News, 2009b; National Statistics, 2009a, 2009b). Despite the strength of the British economy, the International Monetary Fund (IMF) has recently warned the public of the possibility that the overall economic condition in UK can be negatively affected because of the global financial crisis combined with the continuously increasing commodity prices (Tang, 2008). A large number of the UK private banking sector has been negatively affected by the U.S. economic crisis (FT.com, 2008). Because of the monetary problems related to the growing imbalances in domestic and fiscal money borrowing and lending, the entire British economy is likely to suffer the consequences. To determine whether or not he British government and the Bank of England has been successful in running the British economy, evidences pertaining to the degree wherein the British government and the Bank of England failed to run the British economy successfully will be identified and thoroughly discussed. The effectiveness of the fiscal policy will be analyzed in terms of its ability to address the recent problems of the British economy. As part of analyzing the fiscal policy, employment and unemployment rate, gross domestic product (GDP), and budget deficit during the past twenty years will be carefully examined. Likewise, the success of the Bank of England in terms of running the British economy will be criticized. As part of analyzing the subject matter, historical trend behind the exchange rate and inflation rate during the past twenty years will be identified. Based on the gathered information, the monetary policy used to address financial crisis thoroughly examined. As part of the conclusion, whether or not the British government and the Bank of England has been successful in running the British economy will be answered followed by providing some recommended solutions that can improve the British economy despite the global financial crisis many countries are facing today. Fiscal Policy behind the UK Economy Employment and Unemployment Rate The unemployment rate today is the highest since the 1997 Asian crisis. Down by 0.1% as compared to the previous quarter, only 29.38 million or 74.1% of the working age individuals (ages 16 and above) are employed as of January 2009 (National Statisics Office, 2009a). On the other hand, the unemployment rate in the United Kingdom increased up to 6.5% which is 165,000 or a little more than 0.5% higher as compared to the previous quarter (National Statisics Office, 2009a). Basically, the unemployment rate in UK today is the highest level since 1997. The high unemployment rate is an economic indicator that is common when economic crisis occurs. In case there are a lot of people who are unemployed, there is a higher tendency that the demand for local goods and services would also decrease. Therefore, the GDP is expected to decrease as well. (See Chart II – Decline in UK GDP Growth during the 3rd and 4th Quarter of 2008 on page 8) There are few companies that are offering job opportunities despite the global financial crisis. However, it remains a fact that there are a lot of local and international companies such as the Broadcaster ITV, Insurance firm Royal Sun Alliance, JJB Sports, and Standard Life among others that are cutting off jobs in order to reduce its fixed operational costs. (BBC News, 2009c) (See Figure I – UK Snapshot of Job Lost on page 5) Figure I – UK Snapshot of Job Lost Source: BBC News, 2009c Because of the global crisis, large multi-national and other businesses were forced to declare bankruptcy causing the number of unemployed reached up to 3 million individuals (BBC One, 2008). (See Chart I – UK Employement and Unemployment Rate on page 6 – 7) Chart I – UK Employement and Unemployment Rate Source: National Statistics Office, 2009a Source: National Statistics Office, 2009b This is not the first time the UK economy has experienced high unemployment rate. Back in 1997, the unemployment rate in UK was as high as 4.5%. Because of a strong fiscal and monetary policy, UK government was able to decrease the number of unemployed individual down at the rate of approximately 2.3% as of 2007. Particularly in Aberdeen City and Shire, the unemployment rate decreased from 2.6% (9,350 claimants) in 1997 down to 1.0% (2,683 claimants) in 2007. Likewise, Scotland also experienced a significant decline in the levels of unemployment rate from 5.0% in 1997 down to 2.4% in 2007. (National Statistics (NOMIS), 2008) (See Chart II – Unemployment Rates between 1997 – 2007 below) Chart II – Unemployment Rates between 1997 – 2007 Source: National Statistics (NOMIS), 2008 Based on the explanation made by the National Statistics Office (NSO), the sudden increase in the number of unemployment rate today was significantly caused by the large number of young men (111,000 to 1.060 million) and women (52,000) who has recently reached the age of 16 years old (National Statistics Office, 2008b). Even though there has been a significant decline in the employment rate since May 2008, the inactivity rate on working age group which falls at 20.9% remains the same (National Statistics Office, 2008b). Gross Domestic Product (GDP) The Gross Domestic Product (GDP) “measures the output of an economy which has resulted from the production of marketed products and services within the national boundary” (Twiggler, 1998, p. 6). Because of the economic recession during the early 1970s, UK fall below the GDP levels of all other major industrial countries (G7) (Financial Statement and Budget Report, 1997, para 3.01). Even though UK’s GDP per capita fell below the GDP levels of other (G7) countries, UK managed to increase its GDP levels over the years. (Twiggler, 1998, p. 10) (See Chart III – UK GDP per capita between 1974 – 1997 on page 9)   1974 1979 1984 1989 1994 1995 1996 1997 GDP per capita (US$ at current PPPs) 4,259 6,889 10,051 14,284 17,063 17,862 19,153 20,144 Source: Twiggler, 1998 Since the Thatcher’s economic miracle during the mid-1990s, the GDP growth rate in UK has always been positive. For the first time during the past five years, the overall GDP growth during the 3rd and 4th quarter of 2008 was – 1.5% and –1.9% (National Statistics Office, 2009d). (See Chart IV – GDP at Market Prices between 1970 – 2003 on page 10; Chart V – Decline in UK GDP Growth during the Third and Fourth Quarter of 2008 on page 10) Chart IV – GDP at Market Prices between 1970 – 2003 Source: ONS, 2008 Chart V – Decline in UK GDP Growth during the 3rd and 4th Quarter of 2008 Source: National Statistics Office, 2009d Because of the slow economic growth in the United States, the historical GDP trend shows that the British economy has been significantly affected by the global shock. As a result of the global economic crisis, the production output of major industries related to manufacturing, transportation, storage, and communication, construction, mining and quarrying including the electricity, gas, and water output among others decreased between 0.1 – 1.0% whereas the construction and service output fell down to 1.1% and 0.9 as compared to last quarter respectively (National Statistics Office, 2009d). Because of the significant decrease in the household expenditures, the supply of domestic products and services has to go down temporarily in order to reach the equilibrium point. Effectiveness of the Fiscal Policy used in Addressing the UK Economic Problems Effective fiscal policy will enable the UK government to control and prevent the significant increase in the country’s unemployment rate. Once the UK economy is normal, the GDP is also expected to increase over time. Even though the unemployment rate today has increased to 6.5% (National Statisics Office, 2009a), the unemployment rate in UK as compared back between the years1980 to 1986 and 1990 to 1993 is still relatively low. (See Chart VI – UK Unemployment Rate between 1970 – 2005 on page 12) Chart VI – UK Unemployment Rate between 1970 – 2005 Source: ONS, 2008 One of the UK government’s strategies in addressing the economic down turn is to increase the amount of total net borrowings until the economy stabilizes while the collection of tax revenues and VAT receipts increases. (Mulholland, 2008) With regards to the increasing amount of government deficit, Gordon Brown insisted that the fiscal policy of “borrowing money from outside sources was the right thing to do to support the spending during the economic downturn” despite the oppositions with regards to his proposed fiscal policy (Echo.co.uk, 2008). Although borrowing money can help the local government in terms of generating new job opportunities for the unemployed, it remains a fact that there are limitations with the use of such economic strategy. Given that the UK government would fail to have a strong control over the continuously increasing budget deficit, there is a possibility for the UK economy to experience the same negative economic consequences that United States is currently experiencing. Overly increasing the amount of borrowings during a serious global economic crisis may not be the best option to take as a long-term solution because this particular fiscal strategy could lead to a long-term serious economic problem. Today, it is easy on the part of the UK government to borrow money from the banks and outside sources since a lot of investors are more interested in safe investment such as the Treasury bills (BBC News, 2009a). Since it was not stated whether or not the interest rate of the borrowed money is fixed, there is a strong possibility that the UK government will have a serious problem paying back the huge amount of government debt in case the interest rate increases over time. The same scenario was observed during the Thatcher economic crisis wherein UK economy was facing high inflation and unemployment rate. During the Thatcher economic crisis, Lawson decided to cut down the tax collection in 1988 (BBC One, 2008). Because of the sudden decrease in tax collection, the UK government resulted to heavily borrowing of money. The same strategy is being used in addressing the economic problem in UK. However, economists need not rely too much on this particular economic strategy because of the risk that the UK government may not be able to pay back its government deficit in years to come. Upon analyzing the entire UK economic situation, increasing the total net borrowings during a global economic crisis is only a temporary solution. In fact, increasing the amount of government deficit could only result to long-term economic problem because of the possibility that the UK government will be unable to regain a high tax collection aside from the possibility of high interest rates. Based on the research findings of Kersting (2008), distortions found between labor-and-leisure has a significant impact over the economic recovery of UK during recession. Therefore, the local government should also focus on using the fiscal policy to narrow down the gap between the employed and unemployed. Monetary Policy in UK Inflation Rate Even before the recent global shocks was publicly announced, the macroeconomic weaknesses within the British economy has becoming evident. For instance: The domestic demand and supply for goods and services was significantly increasing more than the expected economic growth (Tang, 2008). In general, the economic problem behind the uncontrollable increase in the supply and demand of goods and services is associated with high inflation rate. Basically, when the demand and supply for goods and services goes up, the market prices of goods and services also increases. (See Graph I – High Inflation Rate below) Graph I – High Inflation Rate According to Mervyn King – the Governor of the Bank of England, “hyperinflation can lead to a breakdown of the economy” (King, 2002). Since inflation could make moneyloses its real value, financial problems may arise during an economic recession. Likewise, the local businessmen will have a very difficult time to correct and lower down the market prices given that the household individuals have limited money to spend on merchandises during an economic recession. One of the major factors that causes high inflation rate is due to the market prices of oil. Based on DB Research Report, the global market price of crude oil has tripled since 2005. For this reason, inflation rate in UK reached an 11-year high of 3% back in December 2006 (BBC, 2007). (See Chart VII – Oil Price Tripled since 2005 below) Chart VII – Oil Price Tripled since 2005 Source: Walter, 2008 The government’s target inflation rate should be as low as 2.0%. (BBC News, 2008b) However, inflation rate in UK has reached more than 2.0% since the middle of 2007. Around September 2008, inflation rate in UK reached as high as 16-year high of 5.2% because of the high costs of energy bills (BBC News, 2008b). The problem with having a significantly high inflation rate is the fact that the market prices of local goods and other basic commodities also increases. When this happen, there is a strong possibility for the British economy to experience ‘overheating’. (See Chart VIII – UK Inflation Rate between 1970 – 2005 below) Chart VIII – UK Inflation Rate between 1970 – 2005 Source: ONS and Bank of England, 2008 Upon examining the current economic situation in UK, the main reason for the sudden decline in the total household savings is not caused by a significant decline in the household income but a higher investment spending. In order to prevent the country from experiencing a relatively high inflation rate of more than 2.0%, the UK government should work closely together with the Bank of England to avoid triggering a long-term socio-economic harm. As of January 2009, UK Consumer Price Index (CPI) inflation rate was 3% down from 3.1% back on December 2008 (National Statistics Office, 2009c). During the past 20 years, control over inflation rate was the largest downward pressure that the UK government together with the Bank of England was able to achieve since the market prices of fuels and lubricants significantly fell during the first quarter of 2009. Another major factor that has contributed to the sudden decrease in inflation rate is due to decline in the housing rentals. (See Chart IX – UK Inflation Rate below) Chart IX – UK Inflation Rate Source: National Statistics Office, 2009c Interest Rate The Bank of England manipulate the interest rate as a way of managing UK finances during the period of serious economic crisis. Back in the early 1980s, the interest rates was as high as 17%. Even though the UK government announced the £350 million financial aid for the small- and medium-enterprises (BBC News, 2008c), the high interest rate of 17% made it very difficult for the local businessmen to operate their business during the economic crisis. Since then the Bank of England decided to lower down the interest rate at 10% in summer 1983 (Wearden, 2008). Although the interest rate went up again at 15% back in the early 1990s, the interest rate was showing a downward trend. (See Chart X – UK Interest Rate below) Chart X – UK Interest Rate Source: Bank of England, 2009 As part of convincing the local businessmen to borrow money from the loal banks, the Bank of England decided to lower down the interest rate up to 1% in October 2008 and 0.5% in March 2009. (Wearden, 2008) Given that the interest rate is very low, the UK government together with the Bank of England is expecting the general public to invest their savings in small- and medium-scale businesses rather than simply keeping the money in the bank or invest their money on government bonds (Kollewe, 2009). Exchange Rate Exchange rate is “the price at which the national currency is valued in relation to a foreign currency” (Latter, 1996, p. 5). In reality, exchange rate can either be indefinitely fixed or floating. Because of the economic benefits and consequences fixing or allowing the exchange rate to float in the market, a lot of economists consider the significant role of exchange rate in the monetary policy. The problem with having a strong currency is associated with the fact that major export groups that are based in UK will have a difficult time selling their products and services outside the country. Given that UK exchange rate has strengthened against the US dollar since the year 2003, competitive edge of export businesses throughout the United Kingdom against other exporters around the global markets significantly decreases. On the contrary, having a weak currency has also its negative impact over the UK economy in terms of having a high inflation rate (Latter, 1996, p. 5). (See Chart XI – Exchange Rate USD/EUR between 2001 – 2008 on page 20) Chart XI – Exchange Rate USD/EUR between 2001 – 2008 Source: Walter, 2008 UK exchange rate is free floating. Back in 2007, the exchange rate of British pounds per US dollar at 0.4998 is much higher as compared with 0.5435the previous year (Central Intelligence Agency, 2008). The figure means that the country’s exchange rate in UK has strengthened over the US dollar made them able to purchase more goods when purchasing goods and services outside the country. However, the local businessmen are not able to compete with the market prices of goods and services within the global markets. As of 2008, the exchange rate between British pounds per US dollar is at £0.5499 (See Chart XII – Exchange Rate: British pounders per US Dollar below) Chart XII – Exchange Rate: British pounders per US Dollar 1990 1991 1992 1993 1994 1995 1996 £/USD 0.5633 0.5675 0.5699 0.6663 0.6536 0.6338 0.6411 1997 1998 1999 2000 2001 2002 2003 £/USD 0.6106 0.6037 0.6185 0.6609 0.6943 0.6664 0.6123 2004 2005 2006 2007 2008 £/USD 0.5461 0.5500 0.5435 0.4999 0.5499 Source: OANDA, 2009 Effectiveness of the Monetary Policy Used in Addressing UK Economic Problems The global economic crisis has significantly affected not only the household savings but also the decline in investment and household spending. As a way to manage and control the high inflation rate, it is good on the part of the Bank of England to simply focus on providing liquidity by extending the maturity of money market operations and collateral rather than controlling the monetary policy as a way to control the high inflation rate (Tang, 2008). By allowing the market to balance with the current market condition, the high inflation rate in UK has gradually declined because of the significant decrease in the prices of oil, energy bills, home rentals, food, and lubricants during the first quarter of 2009. During the Thatcher’s era, the inflation rate was as high as 27%. In controlling the high inflation rate, Thatcher decided to control the money supply to keep inflation low (Pettinger, 2007). As part of the economic strategy, the Bank of England increased the interest rate on top of increasing the government taxes and cutting down on government expenditures. Although the economic strategy used back in the early 1980s was effective in terms of lowering the inflation rate, this strategy hindered the economic growth by decreasing the aggregate demand for products and services. As a result, the UK economy has to undergo a serious economic recession. The monetary policy used in addressing the problem behind the UK economic problem is effective for a short-term period. Basically, decreasing the interest rate up to 0.5% will either encourage more people to borrow money from banks or make use of their savings for business purposes. Although lowering down the interest rate is not beneficial on the part of the money lenders, this type of monetary strategy is good in terms of encouraging people to establish and operate small-scale businesses which could promote healthy domestic market environment. This strategy can also be effective in terms of lowering the high levels of unemployment rate. Techniques Used in Collecting Important Data Using the Internet, the researcher managed to get hold on the latest UK economic updates by going through the official websites of the following: (1) Office of the National Statistics Office (ONS); (2) the Bank of England; (3) the International Monetary Fund (IMF); and (4) the World Bank. Eventually, the researcher located for the most recent news report coming from BBC News and Guardian. Evaluation of Research Findings, Arguments, and Date Collected The research findings presented in this report has been based on the latest news report and statistics concerning the economic condition in the United Kingdom. Because of the up-to-date resources, the researcher managed to gather valid information coming from economists behind the fiscal and monetary policy in UK. Because of the huge government deficit, Jonathan Loynes – Economist at Capital Economics stated that “the state of the UK’s public finances continuous to go from bad to worst” (BBC News, 2008a). On the contrary, Gordon Brown insisted that the fiscal policy of “borrowing money from outside sources was the right thing to do to support the spending during the economic downturn” (Echo.co.uk, 2008). The economic idea of Brown is correct in terms of enabling the UK economy to survive within a short-term period. However, economists should also consider the point-of-view of Loynes in order to prevent long-term economic problems which may arise out of heavily depending on money borrowing. Conclusion UK economy is very successful over the past 20 years. Despite the Thatcher crisis, UK managed to successfully keep the economy back into shape. Among the major economic challenges being faced by the British economy is the high inflation rate and government deficit. The high inflation rate in UK two years ago was temporarily caused by the high market prices of crude oil from the outside sources. Now that the market price of crude oil decreases, inflation rate also decreases. The current economic crisis in UK is similar to the economic condition back in the early 1980s. Since history repeats itself, it is important for UK economists to consider the past economic problems and strategies used in managing a long-term sustainable economy. For instance: We have personally witnessed the negative impact of heavily depending on money borrowing by analyzing the economic condition in the U.S. Therefore, UK government should refrain from being dependent on money borrowing. With regards to the high inflation rate, Thatcher insisted on controlling the monetary and fiscal policy in order to prevent inflation rate from rising. As a result, economic recession took place. Aside from lowering down the interest rate to encourage the people to start their own businesses, the Bank of England simply allowed the market to re-adjust with the current market condition. Other than the high government deficit, I conclude that the British government’s monetary policy is good in terms of enabling the British economy survive the global crisis. Bibliography: BBC News. (2007, January 16). Retrieved March 19, 2009, from UK inflation rate at 11-year high: UK inflation jumped to an 11-year high of 3% in December, raising the prospect of more interest rate increases: http://news.bbc.co.uk/2/hi/business/6266263.stm BBC News. (2008a, January 21). Retrieved March 18, 2009, from UK borrowing is worst in 10 years. UK public borrowing surged last month to show the biggest deficit since records began a decade ago, Office for National Statistics figures show.: http://news.bbc.co.uk/2/hi/business/7200775.stm BBC News. (2008b, October 19). 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