Tag Archives | uk economy

The problems of a Scottish currency union

If Scotland gains independence, the Yes campaign has argued that their preferred option is to keep the Pound Sterling and enter into a currency union with the rest of the UK.

This means sharing the same currency Pound Sterling, and having the same monetary policy. Monetary policy would continue to be set by the Bank of England. There would be no exchange rate between the two countries.

Currency Union with the rest of the UK

However, currency unions are problematic. The Eurozone has been a disaster for many European countries who have been saddled with high unemployment and stagnant economies. See all problems of Euro here.

A big problem with currency unions is that in the absence of a lender of last resort, you face pressure to limit budget deficits. Since the Euro was created, Southern Europe has been pushed into more austerity than is desirable. It has left their economies vulnerable and with limited options to deal with trade imbalances and economic downturns.

The Bank of England governor, Mark Carney insisted a currency union with a sovereign, independent Scotland was impossible. “You only have to look across the Continent to look at what happens… A currency union is incompatible with sovereignty.” (Guardian)

Paul Krugman has stated there are great risks of sharing a currency.

Economists (starting with my late colleague and friend Peter Kenen) have long argued that sharing a currency without fiscal integration is problematic; the creation of the euro put that theory to the test. And the results have been far worse than even the harshest critics of the euro imagined, with euro Europe doing worse at this point than Western Europe did in the 1930s:


Krugman goes on to argue that Scotland’s position could be worse than the Eurzone because there is no guarantee that the Bank of England will be interested in acting like Mario Draghi in his support for debtor countries.

An independent Scotland would be dependent on the kindness of the Bank of, um, England, with no say whatsoever in that bank’s policy. (Scotland and the Euro omen)

Currency unions also exacerbate political tensions. People in southern Europe feel let down by economic policy of the ECB and northern Europe.  Germany on the other hand is not happy with the perceived need to bailout its profligate neighbours. Currency unions have not been an effective system for encouraging harmony amongst nations – in fact the opposite. There is a real fear that after independence – Scotland could feel exacerbated and frustrated at being at the mercy of English monetary policy.

But could a currency union between Scotland and the UK work?


Me underneath statue of Adam Smith in Edinburgh

There are some reasons to believe that a currency union between Scotland and the UK would work better than the Eurozone.

Firstly, there is much better labour mobility between Scotland and England than say between Greece and Germany. If the Scottish economy is relatively depressed, workers could move south and vice versa.

A big problem of the Eurozone was  the divergence in wage costs and relative prices. This left southern Europe uncompetitive but without the option of devaluation to restore competitiveness. This is perhaps less likely to be a problem between Scotland and England. If there is a significant divergence in wage costs, readjustment is easier because of the greater capital and labour mobility. Continue Reading →


UK National Debt

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

  • At the end of June 2014, public sector net debt (excluding financial interventions (PSND ex) was £1,304.6 billion, equivalent to 77.3% of gross domestic product.
  • Source: ONS [1. ONS public sector finances ] [This figure excludes temporary effects of financial interventions (PSND ex) (page updated Aug 12th 2014)


Annual Borrowing

  • For the financial year 2013/14, Public Sector Net Borrowing PSNB ex was £93.7 billion  – (5.6% of GDP)
  • The central government net cash requirement (CGNCR) for the financial year 2013/14 was £75.4 billion, £29.6 billion lower than the same period in 2012/13 (£105.0 billion). This figure is lower than PSNB ex because it includes one off receipts, e.g. Royal Mail transfer.


Office for Budget Responsibility

As well as ONS, the Office for Budget Responsibility is a good source for data.

Latest statistics at OBR

Continue Reading →


Impact of rising population in the UK

The UK population is rising and is forecast to rise to over 71 million by 2031. This is a look at the economic and social impact of a rise in the population.

UK Population Households
The UK is bucking the trend of many Western economies, such as Italy, France and Japan – who are seeing low birth rates, an ageing population and declining populations.


UK population projections at BBC

The growth of the UK population raises many issues, some positive and some negative. From an economic perspective, the population growth is generally good news. The growing population will increase the productive capacity of the economy, and help the UK avoid a demographic time bomb through improving tax revenues. However, a growing population will exacerbate existing problems, such as the long standing housing crisis and shortage of supply. To deal with the rising population and congestion, we are likely to see increased building on greenbelt land and a change in the UK’s landscape.

On the one hand, population growth will help the UK economy become one of the largest in the EU, but as a consequence we will have to deal with increased congestion and increased demand on local infrastructure.


The UK is already struggling to meet existing demand for housing. A rising population will put even more pressure on housing; also, the rise in number of households is greater than the rise in the population due to growth of single occupancy households.

As mentioned in housing crisis, the UK already has a persistent shortage of housing. Demand is rising faster than our willingness to build. This shortfall is causing an increase in long-term house prices, reducing affordability. If the UK population continues to grow to 71 million plus it will, ceteris paribus, put upward pressure on house prices. It will require a dramatic change in housing policy and could require large scale new towns to catch up with the shortage.

If supply of housing fails to meet the growth in the number of households, it will increase the cost of living. House prices will rise and the cost of renting will also continue to rise. This is likely to exacerbate the growth in wealth inequality we have seen in the past few years.

Arguably we could deal with the housing shortage, if the political will is there. In the 1950s, we built 400,000 new homes a year. But, given the current resistance to even moderate new home building programmes, 300-400,000 new homes a year will be very difficult.

Limiting the impact of an ageing population

Many countries with declining populations are seeing a rise in the percentage of people over retirement age. This puts pressure on government spending (health and pensions) and leads to lower tax revenues (See: impact of ageing population). The UK population is rising due to net migration and higher birth rates. This means the UK has a higher % of people of working age, who are net contributors to the exchequer (paying income tax, not receiving pensions)

Therefore the growth in the population improves the long-term UK budgetary position, reducing the need for spending cuts and / or tax increases.

The growth in the working age population also increases the size of the UK labour force, enabling higher productive capacity. This will help increase UK real GDP compared to other countries. (note, GDP per capita – GDP per head may not be affected by a growing population.)

Increased efficiency of greater population density

Increased population density is more efficient from both an environmental and economic perspective. The highest carbon per capita consumption comes from rural / low population density areas. There are economies of scale in providing transport and infrastructure which helps reduce the per capita impact on both government spending and the environment.  (Report: increased efficiency of higher urban density) (Study: efficiency of public services from higher density)

Continue Reading →


France vs UK recovery

Useful post from Paul Krugman about a comparison between the French and UK recoveries.

It stems from comments by a Conservative cabinet minister that ‘the French economy is being run into the sand.’

For those who can’t get past the NY Times paywall, I’ll post the two graphs here.


UK and France since 2010


The French economy is forecast to grow by just 1 per cent this year, according to OECD forecasts, compared to 2.4 per cent for the UK.

There are a few observations to be made.

  • Quite often the bigger the decline in real GDP, the more scope there is for a strong recovery. If output falls 7%, it leaves more potential spare capacity. It can make the subsequent recovery appear more spectacular. Despite the depth of UK recession, the recovery has so far been relatively anaemic. For example, after Latvia GDP plunged 15%, they enjoyed a sharp recovery. But, you have to place the recovery in the context of how much GDP fell in the first place.
  • It is difficult to evaluate the success of a policy, such as austerity, solely using quarterly GDP statistics. There are many factors affecting economic recovery. For example, in the UK monetary policy has played a key role in lessening the impact of the relatively small tightening of fiscal policy. France, tied by monetary union has had much less flexibility than the UK in monetary policy.
  • The length of the UK recession was arguably needlessly long.  Even five years after the crisis, we are still to see real GDP return to its pre-crisis peak.
  • Despite the length of the recession and the unbalanced nature of the UK recovery, things are looking a lot more promising than on the continent. The UK economy does have several strengths (as well as weaknesses). See: UK economy in 2014.
  • French government spending accounts for 56% of GDP, the second highest in the Eurozone. French business have been calling for cuts in social security costs to business and lower regulation. Recently, the French government planned to actually reduce the pension age to 60, whearas the UK have been planning to increase the pension age. Given the size of government spending and demographic changes, the French decision was bizarre to put it politely.
  • French unemployment at 11% is y higher than UK unemployment of 7.1%. Part of this may be attributed to more flexible labour markets in the UK. There is a downside of flexible labour markets – zero hour contracts, part-time work, but employment rates in the UK have been increasing. Whearas high labour costs have discouraged employment in France.


At the present moment, the UK economy looks to be in a stronger position. Signs of UK growth are promising, especially signs of manufacturing growth in the north and improved confidence. Though it should be remembered the UK recovery is still weak, helped mainly by consumers spending and a fall in the savings ratio. The French economy by contrast is suffering the European-wide problem of stagnation and low growth.

France may well benefit from some free market reforms and lower government regulation. But, be wary of politicians exaggerating claims about the relative success of economies.



UK economy in 2014

After faltering for several years, the UK economy shows signs of real recovery, with rising spending, investment, exports and even manufacturing growth. At the start of 2014, there seems to be a virtuous circle of falling unemployment, falling inflation, and rising GDP.

After one of the longest and deepest recessions on record, these signs of economic growth are definitely welcome, yet it is far from a return to normality. Real GDP is still 2% below its 2008 peak, and the economy is being propped up by zero interest rates, quantitative easing and a strong housing market. Stagnant wages and poor productivity growth have led to one of the most prolonged periods of declining living standards in memory. Although there is economic recovery, there is still a fear that the recovery is unbalanced, and that the UK economy could be derailed by problems in the Eurozone and future government austerity measures.

Economic growth

economic growthmore on economic growth

The ONS have recently revised annualised economic growth to indicate an annual growth rate of 1.9%. Still below trend rate, but welcome after the several years of falling GDP. For 2014, the OBR forecasts economic growth of 2.4% (BBC link)


 A difficult question is how much of an output gap the UK has. Since 2008, GDP has fallen away from the trend rate of growth. In theory, with output much lower than potential GDP, we would expect a rapid recovery to ‘catch up’ the lost GDP. However, we are unlikely to see this. The great recession has unfortunately led to a permanent loss in real GDP. Economists debate how much spare capacity the UK has. But, for the moment growth rates of 2.5% are unlikely to cause any significant inflationary pressure.



more on inflation

It is ironic that now we are experiencing economic recovery, headline inflation is finally falling closer to the government’s inflation target. of 2%. During the great recession, inflation was often above target due to cost push factors, such as depreciation, rising oil prices and higher taxes. But, now these cost push factors have evaporated, inflation has fallen to 2.1%. Given the nature of the economic recovery, inflation is likely to stay low in 2014, helped by low inflation expectations.

UK Unemployment



Compared with the rest of the Eurozone, UK unemployment could almost be considered a success story. Unemployment has fallen to 7.4% (2.39 million). There is a record number of people in employment (over 30 million for the first time)

However, whilst this unemployment rate is relatively low compared to Europe and also compared to previous recessions, there are other aspects which make less positive reading. Low unemployment has been helped by a rise in part-time employment, temporary contracts, greater job insecurity and falling productivity. (see  UK Unemployment mystery) Also, there are pockets of high unemployment, especially in the north, inner cities and amongst the young. Unemployment of 2.39 million is still a serious social problem, and it will need a considerable period of economic expansion to help reduce to more manageable levels.

Nevertheless, temporary work is still better than no work. Flexible labour markets have many drawbacks, but it is quite interesting that during the shallower recessions of the 1980s and 90s, unemployment rose to a much higher level. There are also promising signs of firms hiring more workers in areas such as, marketing, sales and business development (FT link) which indicate sign of optimism. Continue Reading →


Sustained economic recovery?

Readers Question: Seeing the recent releases of positive UK data come through, I’ve been thinking whether these are signs of a recovery or it is too soon to say. To what extent is the recent run of positive data across sectors a sign of a balanced & sustained recovery in the UK? (question 7th. Nov)

It is a good question. If we look back to 2010, there were signs of economic recovery, but this was not sustained – with the economy going back into recession. In 2013, the evidence is mixed though a little more hopeful. In summary, the UK economy recovery is being primarily driven by consumer spending, the service sector and a vibrant housing market (especially in London). There is weaker growth in manufacturing, exports and investment. The economy is also being helped by ultra-loose monetary policy (Q.E. and zero interest rates). Fiscal policy is more neutral, though over the next few years, the government plans to restrict the growth in government spending so this is liable to be a drag on growth.

These blog posts are also relevant to this question:

Lending and the housing market

A key feature in the nature of the recovery will be the health of the banking sector. The sharp fall in bank lending was a major factor behind the prolonged recession of 2008-12. Signs of improved bank lending will help the economy. However, although mortgage lending shows signs of growth, this is less helpful than bank lending to business. For sustained recovery, increased mortgage lending and squeezing house prices higher is not particularly helpful. Squeezing house prices higher through increased mortgage lending is not increasing productive capacity. If anything rising house prices in London are reducing geographical mobility and the cost of housing in London will adversely hurt the London labour market. Also, house price to income ratios (especially in the south) are close to historical highs; some fear house price growth is unsustainable. Any fall in house prices would knock consumer confidence and spending.

Real Wage growth

In 2013, there has been growth in consumer spending, but this has come despite slow growth in real wages. A feature of the prolonged recession has been very low / zero nominal wage growth. This means, combined with inflation above the government’s target,  many consumers have seen a prolonged fall in real wages. With stagnant real wages, there is a limit to how much consumer spending can lift the UK economy. A sustained recovery will need a return to real wage growth. This may come if inflation falls and firms feel more profitable and able to increase wages. Real wage growth will also require a change in the UK’s very poor productivity growth rate over the past five years.


GDP statistics

Firstly, the latest GDP statistics (preliminary from Q3 2013) were promising:


Source: ONS

In particular, data from Q3 suggested growth across the main industrial sectors of the economy.

In output Q3 compared to Q2, output increased by 1.4% in agriculture, 0.5% in production, 2.5% in construction, and 0.7% in services. This was a rare sign of a more balanced growth. Future growth figures are also looking more optimistic, with analysts predicting strong growth in the next quarter.

But, we always need to add a disclaimer to be wary of quarterly statistics. Firstly, we have to be careful about inferring too much from quarterly economic statistics (especially provisional figures which could be revised up or down later) If one swallow doesn’t make a summer, one or two positive quarterly growth figure don’t overcome a prolonged economic stagnation.

Growing current account deficit and weak exports

Ironically, one day after asking this question, data on exports and the current account deficit was disappointing – raising concerns that the UK recovery was still fragile and unbalanced. Continue Reading →


UK economic recovery

The UK economy has experienced the most prolonged decline in real GDP on record. GDP is still lower than before the start of the great recession in 2008. This unprecedented recession has been prolonged – despite a sharp depreciation in the Pound, and a raft of unconventional monetary policies. However, recent statistics suggest there are some reasons to be more hopeful and the UK economy is starting to recovery. Yet, despite the recovery, many analysts still worry that the economy is unbalanced and could be vulnerable to a further economic downturn in Europe and the rest of the world.

Economic recovery


Source: ONS

The UK recovery since 2009 is best described as ‘patchy’ The important thing is to maintain recovery for a prolonged period and not slip back down into recession. The governor of the Bank of England recently talked about the need for the UK economy to reach ‘escape velocity’ – this means a recovery strong enough for the recovery to be self-maintaining – without the artificial props of quantitative easing e.t.c.

Where is the recovery coming from?

1. Retail spending. Although real incomes remain depressed, retail spending has shown renewed strength. Compared with a year ago (July 2013 compared with July 2012) the quantity bought in the retail industry increased by 3.0% (ONS). Consumer spending accounts for approx 65% of UK GDP, and so is the most important component. A rise in consumer spending is good because it shows a renewed confidence about the economy. However, at the same time it raises concerns. The growth in consumer spending is partly financed by a fall in the savings ratio, it isn’t being met by growth in real incomes. Therefore, there is a danger the UK recovery is falling into the old trap of being unbalanced and relying on consumers dipping deeper into their pockets (and credit cards)

2. Manufacturing. For a long time, manufacturing has been the struggling sector of the UK economy. The weakness of manufacturing is one factor behind the UK’s persistent trade deficit, but recent evidence is more promising. This week, the  PMI survey for the manufacturing sector found the strongest growth in activity for two and a half years, with output and new orders rising at their fastest rate for 19 years. However, although this sounds impressive, it needs to be remembered manufacturing output is still 11% lower than it pre- 2008 peak.


- a long way to recovery.

Construction has also seen growth in the first part of 2013, but, this is from a very weak base, and construction output is still down 0.5% on a year ago. (ONS)

3. Exports to emerging economies. In 2013, we have seen strong export growth to emerging economies. Exports to BRIC countries have performed well. Exports to China have risen nearly six fold since 2002.

Screen Shot 2013-09-04 at 08.32.41

In one sense, these export growth to new markets is encouraging. With Europe stuck in recession, it is good news the UK exporting sector has been able to diversify into emerging markets, which perhaps have greater potential in the long term. However, there have been increasing concerns that the long boom years for China and India may be coming to an end. This would dampen growth in these new export sectors. Also, it is still a small share of GDP for the UK economy.

4. Housing Market. Another staple of the UK economy. A renewed rise in house prices is a mixed blessing. The rise in prices will encourage consumer confidence and improve the balance sheets of banks. It has also encouraged renewed activity in the construction sector. However, house prices are already stretched, with house price to income ratios close to all time high. Rising house prices as a main source of economic recovery is another sign of an unbalanced economy.

Continue Reading →


If the UK had been in the Euro – how would it affect the economy?

Readers Question: my question is If the UK. had joined the Euro back when it first started would the UK. have benefited like Germany or would we be in the same situation as Greece, Italy, and Spain?

If the UK had joined the Euro from the start in 1999, the UK economy would definitely have been affected in a variety of ways. Firstly, in the Euro we would have a fixed exchange rate, no independent monetary policy, fiscal policy would be severely curtailed, and the UK bond market would have had no intervention from the Central Bank.

In short, we could have expected – a bigger housing boom and bust. A deeper recession in 2009. Rising bond yields in 2010-12, leading to greater austerity. No devaluation and less competitive exports.

Housing Bubble

ECB Interest Rates

The years 2000 to 2007 were relatively stable for the Eurozone and Euro. However, due to stronger growth in the UK, ECB interest rates were lower than the Bank of England interest rates. Between 2003 and early 2005, ECB interest rates were 2%, UK rates were higher at around 4%.

UK base interest rates

If the UK had been in the Euro, we could have seen a bigger asset bubble during the years 2003-06. Lower interest rates would have encouraged more people to enter the housing market, causing an even bigger increase in house prices. These lower interest rates would have caused higher economic growth in the period 2000-07, but at the cost of a bigger credit and housing boom. The UK is particularly sensitive to interest rates because so many homeowners have a variable mortgage.

If house prices had risen faster (04-07), they would have been a bigger fall, post 2008. The fall in house prices post 2008 was a drag on consumer spending and contributed to bank losses. If house prices fell at a great rate, then the financial crash would have been more painful and banks lost even more money.

Response to recession of 2008

The economic and financial crisis of 2008 hit the UK more than most other European economies. This was partly because the UK’s economy has a bigger reliance on banking and finance – sectors adversely affected by the credit crunch. Other European economies, such as Germany also saw a big fall in GDP during 2009, but were able to bounce back from recession quicker than the UK and southern Europe.

eu econ growth

In response to this fall in output, the UK pursued a different monetary and fiscal policy to the rest of Europe. If the UK had been in the Euro, we would not have been able to pursue this independent monetary and fiscal policy.

Continue Reading →


Patching up the economy with elastic bands

This week I wrote a post about escape velocity - the idea an economy stuck in recession needs a decisive burst to escape a liquidity trap, low spending and low confidence. If an economy can return to this normal trend rate of economic growth, we can end the period of ultra low interest rates and engage in fiscal consolidation without harming economic growth. Unfortunately, when you’re in a liquidity trap to achieve this escape velocity requires a certain decisiveness, political courage plus understanding of basic macroeconomic theory.

Unsurprisingly, this year’s budget gives not so much a decisive burst, as more an attempt to use a few plastic bands to try and patch up a leaking ship.


In the past five years, the UK economy has shrunk 3% – making the recession longer lasting than even the 1930s. The past three years have seen stagnant economic growth, with no sign of falling unemployment or rising living standards. What the past three years have shown is that in a liquidity trap (interest rates or 0%) tight fiscal policy is contractionary –  no matter how much you try to engage in unconventional monetary policy. The chancellor is still hoping that the Bank of England can work miracles, whilst he reduces government spending. The evidence of the past three years is not encouraging.

Yet, despite clear evidence of the damage done by premature fiscal tightening, the chancellor ploughs on with his plan A – seeming to spend most of his time blaming what a mess we are in. In Europe, EU policy makers have, in the past, attempted to appeal to the confidence fairies. The idea that cutting the budget deficit will restore confidence in the economy and lead to a miraculous economic recovery. The current government also tried to go along with this. The only problem is that it miserably back-fired – with confidence slumping after the 2010 election. The confidence trick of austerity has become one of the great jokes of the past few years – except it’s a joke without much humour.

Continue Reading →

To what extent did EU recession cause UK recession?

Readers Question: to what extent did the EU recession cause the UK recession?

In economics often several factors occur at the same time, and it is difficult to give a weighting to the importance of each factor. To some extent, people will emphasise the factors which best suits their outlook / beliefs.

It is no surprise that the government prefer to blame the double dip UK recession on ‘unavoidable weakness in the European economy’. It is similarly no surprise the opposition blame the government’s austerity approach adopted in 2010.


Source: EU GDP

In theory, the European recession of 2012, will effect the UK economy in the following ways:

  • Lower export demand. With Europe entering recession, they will buy less goods and services, including less demand for UK exports. UK exports to Europe account for around 13% of GDP and so it is reasonably significant. Lower export demand to Europe can have a knock on effect to other related industries, and a possible negative multiplier effect – causing a bigger final fall in real GDP.
  • Reduced confidence. Europe sliding into recession will harm business and consumer confidence. With our main trading partner struggling, firms are less likely to invest in increasing capacity. Also the financial instability in Europe is making banks more nervous and reluctant to lend.
  • Lower inward investment. A recession in Europe will create a disincentive for European firms to invest in the UK leading to lower growth.



But, how important a factor is the European recession?

1. Exports to Europe have not fallen significantly


UK exports to the EU increased between 2009 and 2012  by 6.5%. Exports to non-EU countries increased at a faster rate. During this period, the UK current account deficit increased – because demand for imports increased at a faster rate, and if Europe had not gone into recession, we may have seen a bigger increase in exports. But, overall this still suggests that falling exports to Europe were not the main cause of the recession.  Continue Reading →

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