W the Finnil Crisis (2007) has Affected the UK Econmy - Case Study Example

w the Finаnсiаl Crisis (2007) has affected the UK Есоnоmy Name Institutional Affiliation Date INTRODUCTION The economic recession of 2007 was precipitated by the credit crunch in the US (Macdonald 2012). There was, around this time, a tremendous demand for housing and mortgage facilities. Some banking services chose to offer mortgage services to individuals who did not merit accessing these services, if standard merit procedures were to be applied. This could later lead to bursting of the housing bubble and later spread to all parts of the country. All securities that were tied to housing fell and as a result this led a significant fall in the money markets. In the initial stages, this was viewed as an issue unique with the USA. Little did countries like the UK know that it would affect them as well. According to Goodhart (2009), the crisis spread from the US to the global level and hence threatened a fall in financial institutions. To salvage the crisis, countries had to go into debts. The UK is still paying the debts that it incurred during this period. This assisted, to some level, to reinstate the national governments and banks but stock markets recorded significant drop. Other areas that felt this impact include the housing that catapulted not only into unemployment but also evictions. Different governments put in place stringent measures as part of the response to this crisis. They ranged from borrowing from financial institutions to putting in place monetary policies that would guard circulation of money and even austerity measures to cut down on debts and borrowing. Therefore, the aim of this research essay is to show why interest rates in the UK have remained low since the global economic recession of 2007 and the reasons why these rates might be low in forthcoming years. WHY INTEREST RATES IN THE UK HAVE REMAINED LOW SINCE THE GLOBAL ECONOMIC RECESSION OF 2007 DEMAND AND SUPPLY The law of demand and supply is unavoidable for anyone intending to join the credit business. It is one of the crucial determinants of interest rates. It operates in this sense: where the demand for loans is higher than the funds available the interest rates will definitely go up too. In the recent years, UK government has reduced its borrowing from the internal sources (Goodhart, 2009). This means that very little money is held by the government. Much of the money is out for the public to borrow. For some years now, there is substantial money available to be borrowed by the public thus lowering the interest rates. Another factor is the fact that most companies and business have recovered from the economic recession. There is a significant reduction in the number of companies and institutions that are seeking credit. GOVERNMENT BORROWING High government borrowing either from internal sources or outside can prompt rise in interest rates. As long as governments exist, borrowing is inevitable. For example, in the events of the ailing economy in 2007 the government was prompted to borrow money from financial institutions within the UK and those outside the UK like World Bank (Goodhart, 2009). Part of the money was used to mitigate the effects of the crisis and some was used to run government business. Some sectors of the economy like the construction industry is yet to recover. The government is still making efforts to raise money by borrowing, so as to make it rise on its feet again. Internal borrowing made interest rates to shoot high in the years that followed the economic recession. However, the government has since reduced its internal borrowing and this has led to low interest rates. HEALTHY ECONOMIC GROWTH This is a key determinant in the interest rates. Researchers reveal a close connection between economic growth and interest rest. This comes up because interest rates dictate whether a country is to achieve its economic conditions or not. Rates of interest are key determinants in ensuring that a country limits issues like inflation (Goodhart 2009). In fact, the central bank of England has the authority to either lower or increase the interest rates. Positive economic growth can influence the decision of the central to lower the interest rates like it has done for years now. The low rates of interest in the UK are attributed to gradual and steady growth of the economy since the year 2007. The year 2014 has shown steady growth and this is expected to continue. In the first ¼ of this year the economy grew by a 0.7 per cent in comparison with the preceding quarter. This growth is accrued to the steady input by the services industry as well as the progressive comeback of the construction industry that is still ailing from the effects of the economic recession. The Gross Domestic growth is at 3.0 per cent and this is expected to be steady at 2.5 % next year. These factors are good indicators of healthy economic growth and this can cause fall in interest rate (Goodhart 2009). DECLINING INFLATION Inflation is the sharp escalation of prices of services and goods. This can either be hyperinflation which is rather rapid and can crumble government’s monetary system or stagflation which is often characterised by very high unemployment rates and general economic stagnation (Nesvetailova 2007). When inflation occurs the value of the pound will definitely go down .The purchasing power of the pound is the measure of it’s worth. Relationship between inflation and interest rate High interest rates mean that the money in circulation is less and this can lower the inflation rate. On the other hand, when the interests are low there is more money in the hands of the consumers to spend thus economy grows and so does inflation. The Consumer Price Index(CPI) and Producer Price Index(PPI) and Consumer Price Index (CPI) are key indicators of inflation. Governments consider these tow parameters whenever they want to set interest rates. In the year 2014, inflation in the UK fell to 2.4 per cent .This is what has contributed to low interest rates this year (Nesvetailova, 2007). IMPROVING TERMS OF TRADE Terms of trade are the measure of the exports of a country comparison to its import prices. This is calculated by diving the Index Export Prices by Index import prices and multiplying the sum by 100 (Nesvetailova, 2007).Whenever the terms of trade fall below 100 this is said to be dropping and if it raises above 100 this it is termed as improving. The latter portrays that there is an increase in a country’s imports .This also means a rise in the value of the country. In the recent years, UK‘s terms of trade have been increasing gradually .In September 2014, the terms of trade rose to 100.40 per cent. They have been showing all along an upward trend, a factor that contributes to low interest rates. WHY INTEREST RATES IN UK ARE LIKELY TO BE LOW IN THE COMING YEARS UK HAS A STEADY ECONOMIC GROWTH Nesvetailova (2007) holds that the Gross Domestic growth is at 3.0 per cent and this is expected to be steady at 2.5 % next year. The same sources reveal that consumer spending is likely to rise by 0.3 per cent in 2015 from its current 2.2 per cent. This is because employment is on the rise thus increasing consumer spending. Other areas that are expected to continue growing include business investment. This will definitely give rise to new employment opportunities that will in turn contribute heavily to the growth of the GDP. Although public spending has shown a slowdown this is not likely to change anything but will rather continue to affect the economy for quite some years to come. Figure 1: UK Economic Projections There are several reasons leading to economic growth in the UK. Most services are on their rise after many years of ailing from the recession. For instance, the construction industry (the worst hit by the recession is slowly gaining momentum) creating more jobs and generating more income (Nesvetailova, 2007). Economic growth is key determinant to interest rates .Given the projections given above, it’s certain that interest rates will go down further in the coming years. GOVERNMENT BORROWING Although currently the government’s debt stands 11.8 billion pounds there are signs that this is likely to go down (Nesvetailova, 2007). The government is making strategies to reduce its borrowing. These includes putting in place austerity measures that have seen reduction in public spending.UK also intends to strengthen its tax laws to strengthen tax collection and increase revenue .The other intention is to raise taxes. This is projected that it will reduce its borrowing in the coming years .This will result in making UK attractive to foreign investors who will come and help strengthen the economy by creating more employment. This will help lower interest rates. DECREASING INFLATION IN THE UK UK expects a fall in the inflation rate in the coming years. This is as a result of several factors .Chief among them is the steady economic growth experienced in the last fiscal year concluded in September. Other factors include low rates of unemployment due to recovery of sectors that had gone down in the recession period. Increase in employment rate has boosted consumer spending, a factor that helps bring down inflation (Macdonald, 2012). As mentioned earlier, decrease in inflation influences decrease in interest rates. UK ENJOY POLITICAL STABILITY For a long time UK has enjoyed political stability .Unity among its member states, its cooperation with the EU and countries of the world makes it an attractive investment destination (Nesvetailova, 2007). Note that instability creates uncertainty of the future, a factor that discourages investors. Most countries prone to political instabilities do not attract investment and partnerships that would promote trade and tourism. Very few countries engage in trade with countries often prone to war and terror. Thus, these countries have poor economic development. Investors have tremendous benefit since they help bring growth to the country, make an impact on growth of a country’s currency .These factors are positive indicators of economic growth and thus will make the interest rates stay low. INFLUENCE OF THE EU Since inception of the EU, there have been myriad steps in improvement of the UK economy and other member states. The EU has been /and still provides to the UK, monetary support .Most importantly, the EU has set developmental goals to which UK, as a member state, subscribes to. For example, it’s the intention of the EU that all member states bring their national debts below 60% of their GDP (Nesvetailova, 2007). The EU has other policies that dictate that member countries make effort to reduce their debts significantly to stimulate growth .In response to this ,UK is making efforts to lower its interest rates and there is no doubt that this will go down in the coming years. CONCLUSION In summary, the paper has examined the meaning and context of economic recession of 2007. It has explored reasons why the interest rates have remained low since. Some of the reasons given in this regard include; Healthy economic growth, low inflation rates, Improving Terms of trade and the law of demand and supply. Some of the notable reasons for its likelihood to stay low have been based on the UK economic outlook for the few years to come. However, in addition to this, other factors like the impact of the EU have been cited and explained. From this essay, it is evident that matters of economy ought to be taken seriously and any slight setback in any part of the world would cause a global disaster. The crucial thing we learn from the 2007 recession is to plan ahead, be on alert to avert any variant that can affect the economy at any time. The UK has since learnt. Perhaps next time there is slight negative impact on another country’s economy, UK will be ready to avert it in a better than they did in 2007. References Top of Form Bottom of Form Top of Form Bottom of Form Top of Form GOODHART, C. A. E. (2009). The regulatory response to the financial crisis. Cheltenham, UK, Edward Elgar. MACDONALD, R. (2012). Genesis of the financial crisis. Houndmills, Basingstoke, Hampshire, Palgrave Macmillan. NESVETAILOVA, A. (2007). Fragile finance: debt, speculation and crisis in the age of global credit. Basingstoke [England], Palgrave Macmillan. Bottom of Form Read More