Gross Domestic Product of the UK - Assignment Example

UK GDP and its Recent History Introduction A country's Gross Domestic Product (GDP) is an important indicator of its performance. The most common measure of GDP is called expenditure method which aggregates the country's consumption, investment, government spending, and net exports. Consumption denotes household expenditure for goods and services while investment refers to business spending on capital. Government spending is comprised of public expenses to finance projects to the benefit of the whole economy. Examples are bridges, schools and other public infrastructures. Net export, on the other hand refers to the inflow and outflow of goods and services in the economy. It is computed as the difference between exports and imports. In order to stimulate the economy policy makers employ either fiscal or monetary policies to affect macroeconomic variables. For instance, a decrease in interest rate can boost investment and increase the level of GDP. The current situation of UK is a very common trend in every major economy. After skyrocketing mounts in output levels, growth to start to taper off and enter a showdown. The role of policy makers during this stage cannot be overstated. In order to stimulate the economy, macroeconomic variables are regulated. However, as economics is a social science and policy makers are constrained in analyzing the effects of policies in ceteris paribus, it becomes important that they fully asses the economic repercussions of their implementations. In the United Kingdom, GDP is potent indicator of the economic situation. Looking at the individual components of the GDP will reveal the problems or weaknesses in the economy as well its strengths. This paper will look at the economic performance of the United Kingdom by looking at the recent historical value of GDP. The first part will discuss the behavior of GDP from 1990-2005 and determine the trends underlying this behavior. This report will also try to explain the growth or reduction in GDP by looking at the individual components of GDP. Then, it will discuss the fiscal and monetary policy of UK as well as suggest recommendation to further enhance the performance of the economy. Recent Trends in GDP Figure 1 shows the GDP of United Kingdom from 1990-2005 in billion in constant prices. GDP in constant prices is used following the rationale that it is a more accurate indicator of the real performance of the country. As opposed to measuring GDP in current prices, it relates a realistic situation as it is tied around a base year. The growth rates of GDP in the aforementioned years are also shown in order to describe the behavior of GDP. During 2005, UK reports a 1131.21 billion in GDP, rising by 1.9 percent from the 2004 level and 37 percent relative to the 1990 level. On the average, the economy is expanding at a relatively slow pace of 2.48 percent annually. Sustained growth in GDP is evidenced by the upward trend in the value of output produced. Looking at the growth rates plotted in the other axis, we can see the volatile behavior of GDP with no single trend or pattern. Expansions of output are often followed by troughs which indicate slower growths. In general, we can see positive growth rates with the exception of 1991, when GDP posted a contraction of 1.49 percent. We should also note that since 1993, UK recorded more than 2 percent growth but slowed down in 2005 as it was only able to increase by 1.9 percent. The paper will then conclude with its findings to alleviate the gap in potential and actual output levels. Figure 1 Source: International Monetary Fund World Economic Outlook Database, 2005 Actual and Potential GDP Figure 2 shows the output gap in percent of potential GDP for UK from 1990-2005. At the start of 1990, we can see that the GDP of UK is relatively much higher than its potential GDP evidenced by the positive ratio. In fact, the ratio reached 1.5 which means that UK is producing 50 percent more than its potential GDP. However, this positive ratio had taken a different course in the following year as it dipped by 1.6 and fell to a much lower level in 1992 at -2.6. The gap between actual and potential GDP narrowed during 1994-1997 but started to widen again in 1997. In 2005, the gap between potential and actual output is recorded at -0.03 from the 0.03 level in 2004. Figure 2 Source: International Monetary Fund World Economic Outlook Database, 2005 Generally, the output gap between actual and potential GDP is negative from the period examined which indicates a weak overall demand from the economy's sectors. Cause of the Output Gap Looking at components of GDP, we can see that investment in the country is declining compared to its total output which can partly explain the gap in potential and actual output. During the early 1990s, investment comprises 20.2 percent of the total GDP. Investments did not expand at the same rate as GDP. In 2005, total investment is only 16.7 percent of the total output. Weak demand is also indicated by the country's trade deficit both in goods and services. UK recorded a 3.8 billion deficit in January 2006 with the 2.0 billion surplus in trade in services offset by the 5.7 billion trade deficit in goods. This deficit is greatly contributed by the decline of consumer goods export and aircrafts. Also, there was an increase in capital goods from non-European Union members (National Statistics Office, 2006). Consumer spending is seen to somehow boost UK's GDP. From the available data released by the National Statistics Office in the fourth quarter of 2006, household expenditure expanded, albeit at a slow pace of 1.1 percent in current prices and 0.7 percent volume wise. However, this is not an accurate indicator of overall consumer optimism as boom in spending is often expected during the fourth quarter. Another factor which contributed to the output gap is the US$ 40.981 billion deficit in the economy's current account. Compared to the 1990 level, the values are quite the same. Thus, as time went by, United Kingdom was not able to curb its current account deficit. As of 2005, the deficit represents -1.9 percent of the country's GDP. Slack or Overheating Generally, the economy seems to be overheating as evidenced by relatively high inflation rate and low unemployment. Using 2000 as the base year, the country's inflation rate reached 107.395 in 2005 which indicates a 2 percent increase from 2004. The country is able to curb its unemployment rate as it is down to 4.7 percent in 2005. From the stated economic situation of the country, we can see that what the economy of United Kingdom needs is a mix of slowing down in some areas and stimulus in others. For a large economy like UK, slow growth in GDP is already expected unlike rapidly developing economies like China which hit more than 9 percent GDP expansion in 2005. However, as the country's expansion is generally in a slow down indicated by the falling growth rates and widening output gap between the actual and potential output, some economic stimulus is needed to secure its position in the long run. This paper showed that investment is declining and worsen by the current trade deficit in services. Monetary and Fiscal Policy Currently, the Bank of England the Central Bank of the United Kingdom is pursuing a inflation targeting policy. The institution set an inflation target of 2.0 percent for 2006. This is in line with the Bank of England's goal of "price stability in achieving economic stability more generally, and in providing the right conditions for sustainable growth in output and employment." Aside from this, United Kingdom also sets its interest rate in order to properly control inflation. This is done by the Monetary Policy Committee which meets every Wednesday and Thursday to vote for interest rates. Looking at the interest rates from 2005-2006, we can see that values are set from 4.75 to 4.5. Interest rate during the first three quarters of the year 2005 is maintained at 4.75 but was lowered to 4.50 percent during the last quarter (Bank of England 2006). This decrease in interest rate can signal government's effort in stimulating the economy by encouraging investment and stabilizing prices. In the fiscal side, the government has already set to increase its budget which signals expansionary policy. Recommendation This paper believes that the government and the central bank are already doing what is needed in order to stabilize the economy of the United Kingdom. Lowering interest rates and controlling inflation are imperative in sustaining and stimulating the economy. It is recommended that the government further encourage consumer spending by appropriate policies. It was stated earlier that there is a generally weak demand from consumers who are more inclined to save their money. This can be done by announcing tax breaks to increase their disposable income as well lowering interest rates to discourage savings. The current account deficit should also be addressed by making the domestically manufactured goods more attractive to foreign markets. References: Bank of England. Retrieved April 2, 2006 from www.bankofengland.co.uk HM Treasury. Retrieved April 2, 2006 from www.hm-treasury.gov.uk International Monetary Fund. Retrieved April 2, 2006 from www.imf.org Read More