Benefits of Economic Recovery

A recent OECD report suggested that the UK economy could grow by 3.1% in 2010 (link)

If this forecast proved correct, it would be a real boost for many aspects of the UK economy.

Firstly, it would lead to improved tax revenues. After suffering from the slump in tax receipts during the financial crisis, the government have already benefited from a recovery in taxes on bank bonuses. This growth would lead to improved income tax and VAT receipts.

Growth of over 3% would help to create employment, and unemployment could start to fall quicker than expected. It is hard to know how much employment will be effected because the rise in unemployment was muted given the scale of recession. It may be that firms have tried hard to avoid redundancy, and this may make them slower to take on new workers when the recovery comes. But, strong growth will only improve the employment situation and further help the government finances (less needs to be spent on unemployment benefits)

A strong economic recovery would reassure markets about the UK’s ability to pay off it’s record debt levels. The UK would be more likely to hold onto its AAA rating; and this may enable governments to limit the amount of spending cuts and tax increases necessary to improve budget situation, but which could push the economy back into recession.

Strong growth could push up the value of sterling. After two years of a weak Pound, growth of 3.1% would be one of the highest in the OECD. This could raise the prospect of higher interest rates in the UK. Combined with an improved outlook in public finances, this could make Pound Sterling quite attractive compared to our Euro competitors.

One Swallow Doesn’t Make A Spring.

After two years of almost unending bad news, it is tempting to jump on any piece of good news. Annual borrowing of £190bn is hardly going to be wiped out by one year of economic growth close to our long run trend rate. Growth of 3.1% would still leave much spare capacity in the economy.

The growth rate could be fleeting if other external shocks hit the economy – such as uncertainty during election, continued problems in Eurozone, further oil price rises, more bad news from bank defaults in the finance sector.

But, whilst it is important not to get carried away at one relatively positive economic forecasts, it definitely does make the next chancellors job less frightening. – Another way of thinking about this forecast is imagine the difficulties the UK economy would face if we had another year of zero growth. Unfortunately, this prospect of zero growth and budgetary cuts is a situation facing Greece and most probably Italy and Spain.

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