UK Economy and economic policy


The UK economy has gone through extremely turbulent times in recent years and is now faced with many challenges. Currently the economy is in a state of slow recovery, far from the levels of growth achieved in previous years. The recent banking crisis has highlighted many issues which have become areas of huge debate and policy amendment. This report considers how key Economic variables are useful indicators when analysing the state of the economy, and particularly how they influence business, and the policies which can be used to drive the economy out of recession. It also considers what could happen to the economy in forthcoming years and the impact that present policy decisions will have. Finally, the UK will be faced with several threats, for example, losing its ‘Triple A' credit rating. Although threats are present it is also imperative to consider the opportunities which can arise from a recovering economy. If taken advantage of, they could provide a period of long term prosperity, reducing the chance of a recession again in the near future.


Recently many economic variables in the UK economy have provided a bleak outlook, particularly as they are not at levels which achieve the government's macroeconomic objectives. However, these economic variables are largely dependent on each other; attempting to improve one will see a response from another, so balance is essential. Firstly, an important indicator of the current state of the economy is inflation. The government aims to keep this at a constant rate, focusing on the underlying causes such as demand pull or cost push. Traditionally monetary and fiscal policy have been used to control inflation, perhaps by changing direct taxation or through adjustments to interest rates. Stabilisation policies are essential as significant changes could harm the recovery. By January 2010 the CPI (consumer price index) was 3.5%. Such a high level compared to target might provoke concern. However the temporary rise in VAT is from 15% to 17.5% was a major cause. Although providing adequate explanation, the largest contributors to the increase were cost-push factors, particularly the cost of transport, fuel prices and the cost of second hand cars. In comparison to the EU average of 1.4%, the UK average was 2.9% for these goods. This cost push inflation has had a significant impact on business costs as it is more expensive to distribute goods throughout the country. This has a knock on effect as inflation induced costs have reduced profit margins, investment and consequently demand for labour.










































































A second economic variable which illustrates the current state of the economy is the level of unemployment / employment.

In January 2010 the unemployment rate stood at 7.8% whereas the employment level was 72.2%, the lowest point since November 1996 ( Furthermore the number of people claiming job seekers allowance reached 1.64 million at the beginning of 2010. Although levels of real unemployment have fluctuated, the trend has been a steady increase up until the financial crisis, at 7.75m -8m economically inactive workers. The main reason for the current high level of unemployment in the economy (a sharp rise from 5.5% to 8% of the potential workforce, since the financial crisis) is essentially a lack of aggregate demand, caused by the credit crunch. As a result, firms have either left markets or cut costs, by reducing the labour they employ. Recently the level of unemployment fallen, by 0.1% in January 2010. Whilst promising, there are many reasons why the levels have not increased more. For example, the increased supply of labour has lowered the wage rate to a level where the number of part time workers increases; this has influenced unemployment statistics, creating the illusion of some recovery. These part time workers should be in full time employment, but there is a lack of job availability. Also, because household incomes have fallen, there has been a knock on effect on the economy. Consumption levels are still low in comparison to previous years and so businesses continue to struggle to find demand for their products, in the long run this may force more firms out of the market. It is also likely that current government policy decisions, regarding the imposition of spending cuts to reduce the budget deficit, will create further unemployment.

Gross Domestic Product (GDP) is an important indicator of the problems facing the economy. The UK is the 2nd largest economy in Europe; however it only grew by 0.7% in 2008. Interestingly, average GDP per capita is currently $37,400, whereas the EU average is $33,800. So the UK is still in a relatively strong position compared to many countries within the euro zone. In the quarter from January 2010 output is expected to grow by 0.4%. However, the trend since 2008 has been falling or negative growth, due primarily to the financial crisis. General standards of living are lower because of increased unemployment and personal consumption has fallen from lower levels of disposable income. Also, a lack of export demand and competitiveness has depleted the foreign trade balance. The graph clearly indicates the long term trend of positive GDP growth until the second quarter of 2008. Businesses will be affected by this as GDP is a useful indicator for investors. Many firms will have found it hard to raise capital and continue production without investment - another reason why unemployment has increased.






5th Mar



5th Feb

1.0 %


8th Jan




4th Dec


- 1.00%

6th Nov


- 1.50%

8th Oct


- 0.50%

10th April


- 0.25%

7th Feb

5.25 %

- 0.25%


6th Dec

5.50 %

- 0.25%

5th July

5.75 %

0.25 %

10th May

5.50 %

0.25 %

12th Jan

5.25 %

0.25 %


10th Nov

5.00 %

0.25 %

4th Aug

4.75 %

0.25 %


4th Aug

4.50 %

- 0.25%

Interest rates currently stand at 0.5% and have been at this level for the past year. Low rates encourage consumption and drive investment. Over the past 5 years interest rates peaked at 5.75%, then fell to their present low. The general trend has been 0.25% changes per quarter up until the financial crisis, where rates have dropped more sharply; the largest reduction being 1.5% in November 2008. Throughout this time, larger reductions were justified as a way of trying to increase aggregate demand, reducing the incentive to save and to encourage investment; the aim being to revitalise the ailing economy. Interest rates are the primary tool used by the Bank of England to control inflation. Interest rates influence a variety of factors within the economy; this highlights the difficulty facing the government in balancing the use of economic variables to meet macroeconomic objectives. Interest rates play an important role in the transmission mechanism as they determine the amount of credit that can be obtained. This is currently very limited and is restricting growth and investment. Lower interest rates prevail where a fall in aggregate demand has caused a lowering of equilibrium income and output.

Exchange rates are also a useful indicator. High government debt and recent political uncertainty sees the pound at its lowest level against the dollar for a year. Although in theory the depreciation against the dollar should increase exports and reduce the current account deficit the lack of global demand has prevented this from happening. Consequently this has affected employment and investment in firms which would normally expect an increase in demand for exported goods.

What Will Happen in the Future?

An important indicator of what can be expected in the future is the 2010 pre-budget report. Growth estimated at 1.5% in 2010, reaching 3.5% in 2011 (figures reduced in the March Budget). This level of growth is supported by short term increases in government spending - estimated to rise by £31 billion. However, the government deficit is to be halved by 2013, suggesting potential conflict will arise. Experts, such as the man responsible for managing £618bn in bonds at Primco - Mike Amey, believes that the performance of the sterling will be crucial for the recovery, because of the way it impacts inflation via imported goods prices. Primco also predict a medium-term government deficit reduction - the need for fiscal reform being agreed by all three political parties.

One of the main focuses in the 2010 budget was support for small businesses. Clearly the need to help small businesses survive is essential for the future success of the economy. For example business rates are to be cut for one year, consequently 345,000 small firms will pay no business rate. This is likely to yield many positive externalities, investment will increase, actual output will increase closer to potential output and importantly employment should increase as the smaller firms have a greater profit margin from reduced overheads.

Supply side policies are also predicted to be important in the immediate and long term future as the economy stabilises and recovers. One way of improving the long term stability of the economy is to increase education and training, to enhance Britain's flexible labour market. The only main policy in the budget 2010 was a one off payment to universities to provide more places for maths, science and engineering students. This is perhaps an indicator of what expertise the economy requires, a return to a more productive manufacturing sector, which is the general consensus among many business leaders and economists. The diagram below shows how increased efficiency and labour productivity shifts the Long Run Aggregate Supply to the right over time from Y1 to Y2. The price level remains the same as in the long run as productivity and increased factor inputs are more important.

In the near future the government is likely to rely heavily on Fiscal policy to help offset the effects of demand shocks, in an attempt to reduce the impact on output. Although automatic stabilisers such as unemployment benefit are in place, the government could use discretionary fiscal policy by increasing spending if certain components of aggregate demand are low. The government is likely to continue injecting into the circular flow with particular influence on exports and investment. These will be the main focal points because of the need to reduce the current account deficit. Encouraging investment is essential to increase productive potential and protect the countries AAA rating. Fiscal Policy shifts the IS schedule, increased export demand leads to higher income but also higher interest rates. As shown in figure 6 below.

Principle Threats and Opportunities in the UK

The need for renewable resources and green sources of energy is of growing importance and as levels of non-renewable resources deplete to near critical levels fierce competition is likely to arise both politically and from a business perspective. This can be a major opportunity for the UK to become a world leader and re-establish itself as one of the largest economies in the world. Specialising in an area such as this would result in many positive externalities such as increased employment and increased output occurring because of the multiplier effect. Furthermore if the UK became self sustainable there would be no need to import oil, the risk of supply-side shocks will reduce and sustainable levels of economic growth will occur.

Similarly the imbalance between manufacturing and service sectors is a prominent threat still facing the UK. Importantly the manufacturing sector can help to increase the level of exports, which have fallen by 6.9% since December (the largest monthly fall since December 2006). Despite abnormal weather conditions distorting the figure, it highlights the growing fear that UK exporters need further support.

“Greater Manchester Chamber of Commerce urged the government to do more to support exporters” “Nearly half of survey respondents felt they had lost business to exporters in countries with state-backed export finance schemes.” (Manchester Evening News 9/3/2010 - call to help exporters as trade gap widens)

This view is also supported by the EEF, the manufacturer's organisation. It claims that the government needs to “put manufacturing at the heart of the economy” (Wales Online 6/3/2010 - Put manufacturing at the heart of the economy urges EEF). This claim is made in accordance with the need to re-balance the UK economy. The government can achieve this in a variety of ways, such as sending signals to investors in order to prioritise investment in manufacturing initiatives.


In conclusion the UK faces many obstacles. Currently climbing out of recession it is unclear how long it will take for the UK to return to expected levels of growth, or when unemployment and debt will reduce to acceptable levels. There is still the possibility of slipping back into recession, making management of the economy such a delicate issue. Policies which do not maintain a balance between the key economic variables could cause a further crisis at this fragile point in time. Fiscal policy is likely to be used constantly over the next few years in attempts to create levels of sustainable growth. The use of supply side policies is likely to be key in order to increase output, and it remains to be seen whether measures introduced in the 2010 budget will have a positive effect. The UK has a great opportunity to become a world leader in the provision of green energy, reducing dependency on foreign importers, improving the balance of payments and creating a sustainable long term future. However the government must also address the imbalance between manufacturing / service sectors to minimise the risk of the UK economy slipping back into the realms of uncertainty.

Reference List

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