How would a recession in the US and EU affect the UK economy?
Over 75% of UK trade is with the US and EU. Therefore, a recession in these countries would have a significant impact.
Firstly, UK exports to these countries would fall. Therefore, the UK is likely to have a fall in AD, (or at least lower growth)
Therefore, the UK would experience a lower rate of economic growth. The impact of this fall in exports will depend upon several other factors. The impact will depend upon other factors affecting UK domestic demand. For example, if UK house prices continued to rise and consumer spending remained buoyant, then the UK would be able to avoid an economics downturn.
However, a global recession is likely to adversely affect consumer confidence. Therefore AD is more likely to fall.
A recession in US and Europe would cause a drop in stock markets. This would affect the UK stock exchange which is closely linked to Wall Street this could further reduce business investment and confidence. It would also be more difficult for UK firms to attract capital investment. The problems of Northern Rock were due to the globalisation of capital flows. Due to capital shortages in America, it effected UK banks in their ability to borrow.
Due to a recession in US and Europe, interest rates are likely to fall in these countries. Therefore, the £ is likely to appreciate against these currencies, making exports less competitive and further reduce AD.
The effect on the UK economy may depend on the response of the UK Government and Monetary authorities.
e.g if interest rates were cut, and government spending increased then this may help to increase AD and offset the negative impact of the global recession.
However, in some recessions, consumers become insensitive to interest rate cuts.