Economic Recession in the UK - Essay Example

Running Head: MACROECONOMICS ESSAY Macroeconomics Essay College Recession refers to the drop in GDP (Gross Domestic Product) and it involves the fall in employment opportunities. Recession is one of the stages of the business cycles identified in economics. It generally leads to a slow in economics activities over some time. Several macroeconomic indicators change mostly in the same way. Apart from change in employment status, other changes that take place involve changes in capacity utilization, investment spending, business profits, household incomes and inflation. All these fall during this period. Bankruptcy and unemployment on the other hand rises (Office for National Statistics, 2010). The general belief in the cause of inflation is that recession comes after there is an extensive drop in spending. In combating the problem of inflation, governments usually adopts expansionary macroeconomic policies. These involve increasing the amount of money in circulation, decreasing taxation and increasing government spending. In looking at the case of the UK Economy, it is a good example of the whole process of the period before recession and the macroeconomic conditions prevailing then, the start of recession and the conditions then, the whole recession period and the effect of the government actions on macroeconomic parameters and finally how the economy managed to come out of the recession. The recession in UK economy began after it had experienced two quarters of negative growth in the period between June and December of the year 2008. This led to the falling of the GDP by 1.5 percent during the three last months of the year after the previous quarter had dropped by 0.6%. This is the biggest decline in GDP between two quarters ever recorded after the year 1980. This second quarter experienced the biggest fall in GDP within the same period or quarter. This recession lasted for a period of 18 months and it is the longest recession in the UK economy ever. The economy was characterized by an increased public borrowing of up to approximately 178 bn, and the GDP went down by 6%. Credit Crunch is one of the factors that have been experienced in the UK economy during the recession period. This is an unexpected shortage of money for giving out as loans. As expected this leads to a fall in the amount of loans available. This can be caused by a sudden increase in interest rates, drying up of funds in the capital markets and a control of money directly by a government (Finance Blog, 2010). In the case of the UK recession, the credit crunch was as a result of a sharp increase in subprime mortgages which originated in America but the result was felt in the rest of the world. In the UK, not many bad mortgages where given out like in the US, as it was better controlled than in the US. This however led to a serious problem for Northern Rock which had a high percentage of loans which where risky. It was not able to raise enough funds when the crisis came by in the capital market. It thus resulted to asking the Bank of England to be given emergency funds. Because of this, the customers did not have faith with the bank any more and they thus started withdrawing their funds from the bank. The credit crunch has resulted in an increase in the price for mortgages in UK where mortgages have become expensive (UK Economy Ltd). Another factor experienced due to the recession is falling in prices for houses. This is as a result of the high cost of mortgages which has led to a fall in demand for houses. As a result, the price of houses has been forced to come down and this is a show that many are met with a negative equity. When the prices for houses are low, it means that the banks are not able to get back the initial loan. This has affected the firms dealing with such business like Bradford & Bingley which had specialized in buying and letting which is affected by falling house prices. There is a collapse in confidence in the entire sector of finance. This result in loss of confidence on the sector in the whole economy meaning that the people do not invest anymore in the sector. Another cause of recession is a cost push inflation which compresses incomes and leads to reduction of the disposable income. Cost push inflation is caused by a rise in prices for factors of production and this rise in price is passed to the consumer (HM Treasury, 2009). The Keynesian General Theory of Employment, Interest and Money was written by Keynes an English economist. He is given much credit for shaping the modern macroeconomics and creating the terminology. Keynes intended to bring a revolution in the thinking of economists especially to the thought that a market economy tends to naturally restore itself back to full employment whenever there are temporary shocks. Keynes general argument is that, what determines the level of employment is not price of labor as is considered in neoclassical economics but what determines this is aggregate demand or in other words the spending of money. He sees that it is not right to assume that, in the long run, competitive markets will eventually come to equilibrium or the self-righting equilibrium. He encourages the long turn reduction of interest rates and change of the international monetary system as an important aspect in to encourage consumption and investment by private sector. In application of the general theory to control recession, the government can thus reduce the interest rates. Two factors worsening economic downturns include, reluctance of consumers to put down money that they are suspicious that they might need later incase they are laid off from their jobs and fearfulness for decline in corporate earnings. Fine tuning refers to an intervention made in the short-run into an economy to control fluctuations in demand by the use of fiscal and monetary policies. Looking at the last British recession in the years 1945 to 1970, the British economy changing the fiscal policy in a continuous way to finally stabilize the national income close to full employment as it was possible. Looking at fine tuning during this period, it has been concluded that there was little, if any, success by the use of this method. The problem with fine tuning is that it is difficult in estimating the degree and timing of fluctuations in demand (Ben & Jim, 2006). According to the 2009 budget, the government is committed to maintaining stability so as to be able to achieve its objectives. The goal is to be able to contribute to economic recovery while at the same time ensuring that the public finances are sound. The budget aimed at promoting those who were greatly affected by the economic conditions. In the course of this process, the government undertook to improve the flow of credit to those who are credit worth. The Bank of England cut the Bank rate to %, a 75 billion pounds programme of the purchase of assets was also in plan and the government was also giving fiscal support worth 4% of GDP in 2009-10 by way of discretionary action. The medium term fiscal policies for the government were intended for making sure that spending and taxation had a fair impact between and within generations. The tax and spending plans were set such that they reduced borrowing by 26 billion pounds by the year 2013. More plans are that, form the April of 2010, income tax of 50 percent to be applied to income over 150, 000 pounds and this will be for only those who have an income of over 100,000 pounds. Other changes will be that the government will continue to invest in public services as it goes on providing more savings. Current spending is expected to rise by 0.7 percent in average each year. These steps taken by the government can be termed as Keynesian (HM Treasury, 2008). In conclusion, I have examined government policy in the 2007-2009 and the government policy during this period could be reasonably described as Keynesian because the budget is aimed at promoting those affected by the recession by improving the cash flow for those who qualify for credit and the bank cut the interest rate by half and giving of the fiscal support by government. Lastly, the government made sure that spending and taxation had a fair impact between and within generations References Ben C., & Jim, T. (2006). Macroeconomic Policy and the Political Economy of Coarse Tuning. UK: Cambridge University Press. Finance Blog. Credit Crunch Explained. Retrieved on 28 March 2010, from http://www.mortgageguideuk.co.uk/blog/debt/credit-crunch-explained/ HM Treasury. (2008). Stability and opportunity: building a strong, sustainable future. Budget 2008. Norwich: TSO. HM Treasury. (2009). Building Britain's Future. Budget 2009. Norwich: TSO. Office for National Statistics. GDP and Unemployment Recessions compared. Retrieved on 28 March 2010, from http://www.statistics.gov.uk/CCI/nugget.aspID=2294&Pos=2&ColRank=1&Rank=144 UK Economy Ltd. What caused the recession Retrieved on 28 March 2010, from http://www.howitends.co.uk/2-what-caused-the-recession.php Read More