Entries Tagged 'uk economy' ↓

At the moment, an important economic and political question is when and how to tackle the government’s public sector debt. It is currently over £800bn (56%) but growing very rapidly.

D.Cameron has been making a case that the government debt poses a threat to recovery and it should be tackled with a high priority. He makes the following points.

High levels of government debt could cause the UK to lose its triple A rating status. A downgrade in  status would make it more difficult for the UK to borrow. It would increase the cost of borrowing and possibly force interest rates up. This would hamper a recovery.

Gordon Brown is making a case that the most important thing is an economic recovery. Tackling the budget deficit too early, could stamp out a recovery and push the UK back into recession.

Both are making valid points. It is a concern that UK debt is forecast to grow to 100% of GDP. When debt gets so large it could create problems of financial crowding out (higher interest rates) and possibly inflation, and depereciation of sterling.

However, in a fragile recovery, the last thing you want to do it is to be increasing taxes and cutting government spending, as this will reduce aggregate demand and push the economy back into recession.

Conclusion – So What Should We do?

Personally, I feel that:

The Dangers of borrowing in the short / medium term are often exaggerated. The bond market is not panicking at the level of government debt. Interest rates are bonds are still quite low (true, this has been helped by quantitative easing and purchase of gilts by Bank of England). But, this level of government borrowing is not unprecedented. Other countries have similar or worse, levels of debt. The UK has had much higher levels of debt in the past.

This does not mean borrowing is a good thing and it should not be tackled. Clearly this kind of debt level has to be reduced in the long term. Markets will need assurance that the debt is temporary.

But, I feel the immediate priority is an economy recovery. It is only through economic recovery that we will see a recovery in tax receipts and fall in unemployment (which will of course help reduce budget deficit).

I see little threat of inflation. But, if the economy does recover strongly, it makes sense to tighten fiscal policy (higher taxes) first before monetary policy (higher interest rates)

Related

• How much can government borrow?

The recession could have been worse, but, it still threatens to give the sharpest 12 month decline in GDP on record. (-5.5%)

Despite a few promising signs, the Bank of England’s overall view is still largely pessimistic. They state it could take several years for bank lending to get back to normal. Recent figures on unemployment also present a pretty depressing view, especially for young workers. The Office for National Statistics said that 722,000 people aged 18 to 24 were out of work – one in six

Given state of economy and absence of inflationary pressure, the Bank hinted interest rates could remain close to 0% well into 2010

More analysis on outlook for UK at my other blog – Economic forecasts for UK 2010

Latest Bank of England Inflation report

The UK national debt is the total amount of money the British government owes to the private sector and other purchasers of UK gilts.

From figures published February 18th 2010, UK public sector net debt was £848.5 billion. (or 59.9% of National GDP) – Source: Office National Statistics [1]

Excluding Financial sector intervention, public sector debt is £743 billion or (52.7% per cent of GDP)

The PBR (annual government borrowing) forecast for 2009/10 is for net borrowing of £178 billion or 12.6% of GDP.

Graph Showing UK National Debt

National debt UK : ONS

After a period of financial restraint, National debt at a % of GDP fell to 29% of GDP by 2002. Then, national Debt as a % of GDP  increased from 30% in 2002 to 37 % in 2007. This was despite the long period of economic expansion. It was primarily due to the governments decision to increase spending on health and education. There has also been a marked rise in social security spending.

Since 2008, National Debt has increased sharply  because of:

• Economics Recession (lower tax receipts, higher spending on unemployment benefits)
• Financial bailout of Northern Rock, RBS and other banks.

Although 60% of GDP is alot it is worth bearing in mind, that other countries have a much bigger problem. Japan for example have a National debt of 194%, Italy is over 100%.  The US national debt is close to 71% of GDP. [See other countries Debt]. Also the UK has had much higher National Debt. e.g. after the second world war it was over 180% of GDP.

National Debt and Financial Bailout

The Nationalisation of Bradford & Bingley and Government purchase of shares in major banks like HBOS will cause even more borrowing. It is estimated National debt will could rise close to 100% of GDP by 2012

It is way above the government’s sustainable investment rule of 40% maximum. However, the debt is  different in the sense that the government has a reasonable chance of getting, at least, some of its money back. It is different to say borrowing to pay pensions.

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There are a raft of different methods of calculating government debt. It can be a little bewildering (even for an economics teacher!). I have tried to define the key terms in a simple format and also a more detailed and precise way. This only focuses on the UK.

Defining Public Sector Debt

Simple Way:

• Government Deficit – annual shortfall between spending and tax receipts. The amount the government have to borrow from private sector in a certain year. (see also: PSNCR, PSBR, cumulative public sector current budget)
• Government Debt – The total amount the government owe to private sector (see: also, public sector net debt, national debt, GGGD). This is the accumulation of borrowing over many years.

_{Source: UK Government Debt and deficit ONS}

Debt as a % of GDP

• Debt can be expressed in nominal figures or as a % of GDP.
• in Jan 2009, UK public sector debt was £697bn which = 47.5% of GDP

More Definitions

• Public Sector Net Debt - Total Amount government (central, local and corporations) have borrowed from Private sector – liquid assets. Often referred to as National debt (e.g. in 2009, Public sector net debt was £697bn or 47.5% of GDP
• Public Sector Net Cash Requirement PSNCR – The amount governments need to borrow in a year to meet its shortfall of spending and tax receipts. (e.g. in 2008-09 government has a PSNCR of about £115bn) Often referred to as annual government deficit. Used to be called PSBR (Public sector borrowing requirement).
  - The PSNCR is similar to net borrowing and government borrowing

Debts Not Related to Government Debt

• Current account Balance of Payment deficit – Not related to public sector net deficit. current account deficit related to level of net imports
• External debt – Total amount that UK owes foreign countries. External debt includes government liabilities + private sector liabilities; it is not directly related to public sector debt.

More Detailed Definitions

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There is little grounds for comfort in the economy, with Ministers admitting that it could be the worst recession since the war.

On the surface it appears that the bust has come without any preceeding boom. Though, the economy still displayed aspects of boom and bust. See: Bust without boom?

It has led to a war of words between the German finance minister and the UK. The German minister criticised the UK for crass Keynesianism. Yet, he should perhaps concentrate on Germanys problems – high levels of public debt and their own recession. See: Germany v UK Economy

The continued weakness of the Pound is a reflection that the UK economy has been hit hardest by the global downturn. The UK economy has been hit the hardest mainly because:

1. Housing boom and bust is most noticeable in the UK. The UK is seeing rapidly falling house prices and house prices are traditionally very influential in influencing the UK economy.
2. The UK derives a large portion of its economy from the finance sector and this has been badly affected by global credit crunch
3. Domestic saving is very low, so with onset of rising unemployment and low expectations people are seeking to boost their savings and reduce borrowings.

Readers Question:

1. critically examine the effectiveness of monetary policy.

2. what factors do you think limit the effectiveness of monetary policy.

Previously, I have written an essay – what determines the effectiveness of monetary policy

In brief, the aim of monetary policy is to target low inflation (CPI = 2% +/-1). But, also to maintain a steady rate of economic growth. In recent months it has been difficult for the Bank of England to achieve both these objectives. This is because we have had cost push inflation (rising oil, food prices). The cost push inflation causes rising prices and falling economic growth. Therefore, even though inflation has increased to over 4%, the Bank don’t want to increase interest rates because the economy is already slowing down. Therefore, they have left interest rates the same and have been unable to keep inflation on target.

However, in period 1997-2007, monetary policy effectively kept economic growth and inflation stable. This was because cost push inflation was low and the independent Bank of England was successful in preventing growth exceeding the long run trend rate.

Readers Question I’m currently looking at stagflation in the mid 1970s in the UK, and the policies the then-Government undertook to solve the economic crisis.

Was the Government right to widen the budget deficit 1974-5 in order to stimulate demand, or should it have run less expansionary policies to temper the effect of rising prices?

I’m afraid I don’t have access to many statistics from the 1970s, so it is hard to make much analysis. But basically, the government faced a twin problem of rising prices (mainly cost push) and falling demand. (Stagflation) By pursuing expansionary fiscal policy, they were attempting to maintain full employment ( a noble objective). However, it led to a rise in inflation and inflation expectations. Combined with powerful trades unions in the 1970s, this led to a sharp rise in inflation (25% by 1979). Arguably these rates of inflation were costly for the economy and led to an almost inevitable recession in 1980. see: recession 1980-81

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There are signs that the long period of economic growth may soon be ending.

For a long time the UK economy has been bolstered by rising house prices and strong demand from the consumer. However, a series of very disappointing results on the high street suggest that consumer confidence has fallen significantly in the wake of rising living costs and falling house prices.

A full blown recession (negative economic growth) has yet to materialise, but, the signs are for a sharp slowdown.

The data will be of little comfort to the government (facing a record level of government debt – £60billion)

it will also be of little comfort to the MPC, who have to balance the twin problems of inflation and lower growth

• Is UK Heading towards recession?
• Business chiefs and Economists give their opinion at Telegraph

Readers Question: explain why two sectors of the UK economy are growing faster than other sectors ?

According to the Office of National Statistics for March 2008

• Retail Sales Volume Seasonally Adjusted (2000=100) increased to 140.3 an annual growth rate of 4.7%
• Manufacturing grew at only 0.9%
• Services grew at 3.2%

latest statistics at ONS

I have to admit I was a little surprised to see retail sales increase at 4.7%. Anyway it seems that retail sales and the service sector are still doing much better than manufacturing and production. These are some potential reasons.

Exchange Rate. Against the dollar, at least, the Pound has been strong. This makes our exports more expensive reducing demand. Manufacturing goods are often exported so would explain weakness of manufacturing sector. Imported goods become cheaper so may boost sales on the high street.

• However, the pound has been weak against the Euro, our main trading partner, so I doubt how important this factor is.

Interest rates. The Bank of England has cut interest rates to 5%. In theory this should boost spending because it makes borrowing cheaper. This would explain increased retail sales and services because consumers will have more spending power.

• However, the cuts in base rates have often not been passed on by banks. The credit crisis has led to a tightening of lending restrictions. This is why I was a little surprised to see retail sales growing so strongly.

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Readers Question: How does the UK’s economy compare to other European countries such as France in terms of the UK’s seeming reliance on House Prices and consumer confidence to drive the economy. Is there a better way and why don’t we use it.

I was interested in making a comparison between the UK and French economy. and wrote an Essay on The French vs UK Economy.

Generally speaking, most economists argue that the UK economy has performed  better than the French economy in recent years. However, you are right to suggest that the UK economy has relied to a large extent on consumer spending, driven by rising house prices. Arguably this growth has been unbalanced and if house prices fall significantly it will lead to lower growth in the UK and in the future, the situation could be reversed.

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