EEP 2 Report

7/31/2019 EEP 2 Report

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UK economic crisisEEP-2 REPORT(GROUP 7)

Animesh(11P066)

Aditya Bansal(11P064)

Anupriya Asthana(11P069)

Nitin Kumar Gupta(11P094)

Prithi Singh(11P099)

Yashwanth Reddy(11P120)


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ContentsIntroduction .................................................................................................................................................. 3

Reasons for UKs Turmoil .......................................................................................................................... 5

UKs Austerity Programme............................................................................................................................ 5

Overview: .................................................................................................................................................. 7

UK economys assessment........................................................................................................................ 8

UK economic outlook .............................................................................................................................. 11

Double dip in 2012? ................................................................................................................................ 12

favourable factors to help recovery next year........................................................................................ 14

References .................................................................................................................................................. 17


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techniques. Agriculture in the UK is also highly subsidised, both by the UK government and the EUs

Common Agricultural Policy.

Industries and manufacturing on the other hand is extremely important if the UK wishes to reduce its

trade deficit. The UK is the sixth-largest manufacturer of goods in the world according to the value of

its outputs. Within manufacturing, the production of automotive or aerospace equipment is a major

contributor to UK industries. UKs aerospace industry is the second largest in the world with companies

such as BAE Systems (the worlds second largest defence contractor), and Rolls-Royce (the worlds

second largest aircraft engine maker) boasting annual turnovers of around 20 billion.

However, despite the historical importance of agriculture and industries, services remain the dominant

component of UKs economy.Finance and banking are by far the UKs most important services with

London being one of the three major economic command centres alongside New York City and Tokyo.

Important financial institutions located within London include the London Stock Exchange, the London

International Financial Futures and Options Exchange, the London Metal Exchange, Lloyds of London,

and the Bank of England.

Tourism is another extremely important service in the UK. With more than 28 million tourist arrivals in

2009, the tourism industry is worth nearly 80 million annually. According to tourism agency Visit

London, the 2012 London Olympics will be a boost to the UKs economy providing an additional

US$2.457 billion to the economy over ten years.


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Reasons for UKs Turmoil

UKs Austerity Programme

Part of the reason for UKs slow economic growth has been due to the recent introduction of an

austerity plan. The UK austerity plan was introduced as a method to reduce record level debts that

were exacerbated by the 2008 global financial crisis. Apart from cutting public spending and services,

the UK government have also implemented a new wave of tax increases. However, while these methods

are fundamental in reducing debt, they tend to hamper economic growth in the short term as well.

According to the Chief Economic Adviser for the Confederation of British Industry Ian McCafferty, The

recovery continues to be choppy and lacking in vigour. Expansion in certain sectors is being offset by

weaker performance in others. What remains striking is how little we expect the pace of growth to

accelerate in 2012, and that it will be far less robust than we'd normally expect in the second and third

years of a recovery.

In the wake of the recent economic forecasts, the austerity plan has once again been called into

question. John Evans, general secretary at the Trade Union Advisory Committee to the OECD warned

that the UK austerity plan could be a vicious cycle, not a virtuous cycle. Prominent economist Nouriel

Roubini also expressed concern over the likelihood of stagnation and double-dip recession.

High Trade Deficit

One direct effect of the UKs budget deficit has been the ever-increasing trade deficit that the UK suffers

to the rest of the world. The UK has the second highest trade deficit in the world behind the US. In

2010, UK imports were worth US$546.5 billion with exports were valued at only US$405.6 billion.

Despite recent attempts by the government to reduce the trade deficit, the latest data from UKs Office

of National Statistics points to a widening trade gap.Since the beginning of 2011, UKs monthly trade

deficit has hit record levels of more than 4 billion per month. The monthly deficit in the UK for 2011 is

also exceeding the previous record level of 3.5 billion per month reached in 2007.

High Inflation

UKs current inflation rate is also threatening to sabotage the UKs government austerity plans to keep

interest rates under control.According to Justin Knight, head of European rate strategy at UBS, What

has been driving UK yields is the prospect or risk of inflation, which has to be priced in. There are distinct

concerns about inflation."


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In 2011, the UKs inflation rate (average consumer price change) is expected to be more than double

of what the UK government had previous targeted 4.2 percent compared to 2 percent.


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Overview:

The UK economy emerged from the 200809 recession with elevated public and private debt and high

unemployment. Strong growth and macroeconomic stability in the runup to the crisis had hidden a

buildup of significant imbalances, influenced by overreliance on debtfinance and the financial sector,and booming asset prices. These imbalances need to be addressed to ensure a sustainable and balanced

recovery. The government is pursuing a necessary and wide ranging programme of fiscal consolidation

and structural reforms aimed at achieving stronger growth and a rebalancing of the economy over time.

A broad based recovery started in end2009, but faces significant headwinds during 2011, which can

be mitigated by monetary policy remaining supportive. The planned fiscal consolidation is needed to

ensure that the fiscal position will be sustainable over time. Nonetheless, it adds to the headwinds from

weak real income growth and a fading rebound in global trade. Monetary policy should hence remain

expansionary, even if headline inflation is significantly above target, to support the recovery.

While the governments fiscal plans and reforms to the fiscal policy framework have significantly

reduced fiscal risks, further improvements to the fiscal framework and reforms to make the financial

sector more robust are needed. The government has embarked on an ambitious and necessary fiscal

adjustment and strengthening of fiscal institutions, including the welcome creation of the Office for

Budget Responsibility. Steps towards establishing a permanent fiscal framework should start to be

undertaken as the public finances are returned closer to balance. The creation of a Financial Policy

Committee will strengthen macroprudential policy, but further steps are needed to deal with banksthat

are too big to fail.

Reforms to housing policy should aim to increase affordability and mitigate excessive house price

volatility by enhancing the supply of available land and reducing the volatility of housing demand .

Rigid housing supply and fastrising demand have fuelled house prices, reducing affordability and

contributing to macroeconomic and financial instability. Policies to increase supply should focus on

lowering barriers to access to land for housing and providing sufficient incentives for local communities

to allow development. The current system of housing taxation is regressive, encouraging excess demand

for housing and should be modified to better reflect the value of ownership.


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TABLE 1: Main economic indicators for UK

UK economys assessment

1. The global financial crisis and the associated recession ended a 15year period of continuous growth,

rising employment and stable inflation. Significant imbalances had developed, however, in terms of

public and external deficits, an excessively leveraged financial sector, high house prices and low

household savings. The imbalances exacerbated the downturn during the global recession and

contributed to a more pronounced fall in GDP, a larger fiscal deficit and higher inflation than in most of


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the OECD. A wide range of policies were introduced to support the economy and the financial

sector,some of which are now being scaled back.

2. The broad based recovery that started in end2009 slowed in the second half of 2010. The recovery is

likely to remain subdued in 2011, as the necessary fiscal tightening and a fading rebound in world tradecreate headwinds, before picking up again in 2012. With general government net lending close to 11%

of GDP in 2009, a substantial tightening was vital to achieve a sustainable fiscal position and reassure

investors. Fiscal consolidation will impact significantly on government consumption, investment and

household income growth in 201112. Financial conditions are improving, but the financial sector

continues to benefit from crisisrelated support schemes and ultra-low policy rates which will eventually

be withdrawn. Slow real income growth will hold back household consumption.The response of net

trade to the depreciation of sterling and the recovery in export markets has so far been disappointing,

although manufacturing exports have picked up strongly from a low base. But, as service exports start to

recover, relative export performance is set to improve. Investment has also started to pick up and is

likely to grow stronger in response to shrinking excess capacity in manufacturing and low levels of

housing investment. All in all, a subdued recovery is expected over the next two years, largely driven by

a rebalancing of the economy towards rising net exports and increasing investment.

3. The labour market has proved to be comparatively resilient in the recession, although unemployment

has risen. Labour market adjustment comprised a significant fall in real wages due to high inflation, but

also due to nominal wage restraint and shorter average working hours. The labour market recovery is

expected to be slow, reflecting a subdued recovery, spare capacity among firms and shrinking public

employment. Unemployment is expected to fall gradually. Low skilled workers and youth have been

particularly hard hit during the recession, pointing to the importance of maintaining efficient

employment services, strengthening work incentives and improving educational outcomes.

4. Significant global and domestic risks remain to the projection. Household consumption may be

weaker than expected in response to sluggish growth in real incomes, a further fall in housing prices or

fasterthanexpected increases in interest rates. Exports may recover slower or faster, reflecting

uncertainty about global demand and the longer term impact of the depreciation of sterling on

exports.Furthermore, the ability of financial sector exports to recover their precrisis level is uncertain.

Business investment may, on the other hand, recover more strongly than expected.


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5. The government is pursuing a necessary and wide ranging programme of fiscal consolidation and

structural reforms aimed at achieving stronger growth and a rebalancing of the economy over time.As

discussed below, reforms to improve educational outcomes and the functioning of the housing market

could raise productivity and long term growth. A simpler welfarebenefit system with stronger work

incentives and stronger support for activation, as outlined in the planned Universal Credit reform and

the new Work Programme, could improve labour market outcomes. Furthermore, the required fiscal

consolidation will imply that private sector activity will need to lead the recovery. The government has

announced reforms to corporate taxation aiming at lowering firms tax burden. The ongoing

GrowthReview needs to address a range of obstacles to private sector growth.

Figure 1: Fiscal outlook and consolidation


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UK economic outlook

The UK likely re-entered recession at the end of 2011. Near-term prospects are bleak with anumber of headwinds hampering the recovery. In particular, falling demand from continental

Europe, continuing fiscal retrenchment and weak consumer and business confidence will keepGDP growth down to only 0.3% in 2012. Unemployment is projected to rise to close to 9% by the

end of this year.

But growth should gather pace in the later part of 2012 and average 1.9% in 2013.Key to thispick-up in activity is an expected fall in inflation that ends the squeeze on consumers

purchasing power. In addition, assuming that business confidence improves, sound balance

sheets mean that companies can accelerate investment spending.

We judge that there is currently a significant amount of spare capacity in the UK economy.However, growth in the capacity of the UK economy is likely to be relatively slow in the short

term, constrained by tight credit conditions. We expect potential output growth to average only

1.6% over the period to 2016. GDP,however, is expected to grow on average by 2.1% a year over

the next five years as the output gap gradually closes.

Our short-term forecast is somewhat weaker than both the Office for Budget Responsibility(OBR) forecast and the market consensus, although in our view this discrepancy is largely a

question of timing, with other forecasters -- - including theOBR -- - likely to downgrade their

forecasts in the next few months.

While our baseline forecast may appear to be rather gloomy, particularly in the short term, therisks remain heavily skewed to the downside. The most serious threat comes from the prospect

of an escalation of the Eurozone sovereign debt crisis, with a series of defaults and exits from

the Eurozone having the potential to cause another deep recession in the UK.

Barring unforeseen shocks, CPI inflation should fall back to target by early 2012. Although recentinflation outturns have exceeded the 2 percent target, this overshoot reflects price level shocks

related to the January 2010 VAT increase, rebounding global commodity prices, and continued

pass-through from earlier sterling depreciation. Another VAT increase in January 2011 will keep

headline inflation above target next year. But over time the existing margin of spare capacity,

along with fiscal tightening, will impart a significant disinflationary impulse. As a result, inflation

should gradually revert to target as temporary effects dissipate and economic slack keeps

underlying wage and price pressures in check.

Upside and downside risks are balanced, but uncertainty around the central scenario isconsiderable: On the upside, expansionary impulses from very low real interest rates, past

sterling depreciation, and the ongoing recovery of global demand could be greater than

expected, boosting the UK economy onto a faster-than-expected growth path. This scenario

would likely entail higher global commodity prices and stronger inflationary pressure.

However, downside risks are also sizeable, given the continued fragility of confidence, still-

strained balance sheets among households and banks, signs of renewed housing market

weakness, and the possibility that headwinds from fiscal consolidation could turn out to be

more powerful than expected. Although it is unlikely and not unique to the UK, an adverse


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scenario where major new shocks - arising from either external forces or domestic ones - trigger

another extended contraction in output cannot be ruled out.

Souce: Andrew Goodwin (Oxford Economics)

Double dip in 2012?

The UK enters 2012 from a weak position

The preliminary estimate for GDP growth in 2011Q4 showed that output contracted by 0.2% atthe end of last year. Official monthly output estimates had shown manufacturing activity drifting

down through the summer, but greater resilience in the services sector.However, the escalation

of the Eurozone crisis from late July caused a sharp decline and increased volatility in equity

prices, which in turn damaged sentiment amongst both businesses and consumers. This was

reflected in a steep downturn across a number of the key business surveys in the autumn, but

the damage to the real economy was most apparent in Octobers official monthly outputestimates, with the manufacturing and services sectors having seen month-on-month declines

of 0.9% and 0.6% respectively

Decembers Purchasing Managers Index (PMI) surveys were less weak than in precedingmonths, but activity balances remained well below the levels reached in early 2011 and the new

orders pipeline remained weak. We are forecasting that the UK economy will endure a technical

recession in 2011Q4 and 2012Q1.

The descent back into recession was caused by a range of international and domestic factors.The global economy slowed sharply during 2011, firstly because of a soft patch in the US and

latterly as a result of the escalation of the Eurozone sovereign debt crisis. This has been

particularly damaging for the UK because of its heavy reliance on the Eurozone for its exports(see Chapter 1). We estimate that growth in world trade, weighted by UK export shares, slowed

from 13.4% in 2010 to 6.4% in 2011. The uncertainty over the future of the Eurozone has also

had a negative effect on domestic demand in the UK. Surveys of business and consumer

sentiment have dropped back to levels last seen during the recession of 200809, and this has

translated into a reluctance to spend until the uncertainty clears.

Furthermore, though weaker global growth has been reflected in lower prices across a range ofcommodities, including food and metals, oil prices have remained at historically high levels.

Social and political tensions in the Middle East have increased concerns about supply

disruptions, raising the risk premiums. As a result, retail petrol prices have barely fallen from

their April 2011 peaks. And, with domestic energy bills also increasing by more than 10% in

Autumn 2011, households finances have remained under severe pressure.

Domestically, the austerity programme has been a significant drag on growth in recent quarters.The increase in the main rate of VAT in January 2011 added around 1 percentage point to

inflation in 2011, exacerbating the squeeze on consumers. Moreover, government investment

has been cut sharply. We estimate that it reduced GDP growth by 0.3 percentage points in 2011.

The austerity programme has also dampened net job creation. The pace of job losses in the


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public sector has been considerably faster than the OBR had originally forecast and, with

economic growth faltering, the private sector found it increasingly difficult to create sufficient

jobs to offset the drag from the public sector.

The subsequent increase in unemployment has reinforced the pressure on households andfurther damaged confidence.In addition, credit conditions still remain tight relative to historical

norms. Small and medium-sized firms, in particular, continue to find it difficult to access the

credit they require, which is constraining their ability to invest and to expand production.

Furthermore, although UK banks have not implemented the type of credit tightening seen in theEurozone, there were signs towards the end of 2011 that higher interbank rates were beginning

to increase the cost of credit, particularly for firms.


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Favourable factors to help recovery next year

Monetary policy is likely to remain supportive

One factor supportive to growth will be monetary policy, which is expected to remain very

accommodative with the possibility of even further easing from the Bank of England (BoE).

Low bond yields

Our research suggests that quantitative easing has a significant impact on longer-term interest rates. We

estimate that QE equivalent to 10% of GDP depresses 10-year government bond yields by around 1

percentage point (100 basis points). The BoEs programme has therefore been a key factor contributing

to the significant fall in 10-year UK gilt yields, to below 2% in January 2012. As the QE programme

remains active, bond yields should stay low.

In addition, UK gilts are benefiting from a safe haven status, as investors move away from riskier

government bond markets, in particular in some Eurozone countries. With uncertainty about theresolution to the Eurozone crisis, or indeed the future of the Eurozone, likely to be high throughout the

year, UK bond markets should remain very attractive.


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Inflation to fall sharply

Another support to growth is expected to come from a sharp fall in inflation, which has already begun.

The bulk of the rise in inflation to over 5% during 2011 can be attributed to one-off or temporary

factors, such as higher VAT or food and energy prices. As those increases fall out of the year-on-year

calculation, inflation is set to fall under 2% (Figure 2.10). The most significant drop in inflation rates is

likely to come in early 2012, as the impact of the increase in the main rate of VAT in January 2011 falls

out.In addition, we expect further falls in oil prices this year, which will also contribute to lower inflation.

Assuming that concerns over oil supply abate, slowing demand should pull Brent prices down towards

$100 per barrel by the end of 2012. Non-oil commodity prices are also forecast to fall this year, on the

back of weaker global demand.


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References

http://www.economywatch.com/world_economy/united-kingdom/

http://www.britishchambers.org.uk/policy-maker/economic-data/quarterly-economic-survey/

http://webarchive.nationalarchives.gov.uk/20100407010852/http://www.hm-

treasury.gov.uk/ukecon_imf_articleIV2009.htm

http://www.niesr.ac.uk/pdf/020212_170728.pdf

http://www.hm-treasury.gov.uk/ukecon_index.htm
http://www.economywatch.com/world_economy/united-kingdom/http://www.economywatch.com/world_economy/united-kingdom/http://www.britishchambers.org.uk/policy-maker/economic-data/quarterly-economic-survey/http://www.britishchambers.org.uk/policy-maker/economic-data/quarterly-economic-survey/http://webarchive.nationalarchives.gov.uk/20100407010852/http:/www.hm-treasury.gov.uk/ukecon_imf_articleIV2009.htmhttp://webarchive.nationalarchives.gov.uk/20100407010852/http:/www.hm-treasury.gov.uk/ukecon_imf_articleIV2009.htmhttp://webarchive.nationalarchives.gov.uk/20100407010852/http:/www.hm-treasury.gov.uk/ukecon_imf_articleIV2009.htmhttp://www.niesr.ac.uk/pdf/020212_170728.pdfhttp://www.niesr.ac.uk/pdf/020212_170728.pdfhttp://www.hm-treasury.gov.uk/ukecon_index.htmhttp://www.hm-treasury.gov.uk/ukecon_index.htmhttp://www.hm-treasury.gov.uk/ukecon_index.htmhttp://www.niesr.ac.uk/pdf/020212_170728.pdfhttp://webarchive.nationalarchives.gov.uk/20100407010852/http:/www.hm-treasury.gov.uk/ukecon_imf_articleIV2009.htmhttp://webarchive.nationalarchives.gov.uk/20100407010852/http:/www.hm-treasury.gov.uk/ukecon_imf_articleIV2009.htmhttp://www.britishchambers.org.uk/policy-maker/economic-data/quarterly-economic-survey/http://www.economywatch.com/world_economy/united-kingdom/

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