The Global Economic Crisis and UK Macroeconomic Policymaking
Extract A
UK Growth, Inflation and Policy Interest Rates
BaseGrowth
Interest
Rates
UK Real GDP
and
Consumer Price Inflation. annual percentage change
Percent
Percent
6
6
Policy Interest Rates
5
5
4
4
3
3
2
2
1
1
0
0
6
5
4
3
2
1
0
-1
-2
-3
-4
-5
6
5
4
3
2
1
0
-1
-2
-3
-4
-5
Consumer price inflation
Real GDP growth
02
03
04
05
06
07
08
09
Source: Reuters EcoWin
Extract B
The UK is highly integrated into the global economy. As for any country, this tends to
increase the sensitivity of the economy to external events and developments in other
countries, inevitably affecting macroeconomic performance including growth and jobs.
The UK government's long-term economic goal is to secure and maintain economic
stability, in order to achieve its objective of a fair society where there is security and
opportunity for all. The world economy was hit by a succession of external demand and
supply-side shocks during 2007 and 2008, with the financial crisis of late 2008 leading
to a steep and synchronised global economic downturn. There was also a steep rise in the
world prices of many fuels, industrial metals and foodstuffs although commodity prices
have since fallen as the world economy has slowed down.
Although Western governments may have staved off a collapse in financial systems
through emergency bank re-capitalisations and bank-funding guarantees, banks remain
sick and are clamping down on credit as they seek to shrink swollen balance-sheets.
There has also been a collapse in global trade focused on capital goods and cars. Whereas
the USA, the UK and Europe have been most affected by credit rationing, Asian
economies like Japan have been hit hardest by the fall in trade volumes.
Many OECD economies are in or are on the verge of a protracted recession of a
magnitude not experienced since the early 1980s. As a result, the number of unemployed
in the OECD area could rise by 8 million over the next two years. At the same time,
inflation will abate in all OECD countries and some even face a risk, albeit small, of
deflation. Against the backdrop of a deep economic downturn, additional macroeconomic
stimulus is needed. In normal times, monetary rather than fiscal policy would be the
instrument of choice for macroeconomic stabilisation. But these are not normal times.
Source: OECD World Economic Outlook, November 2008 and National Institute Economic
Review, Jan 2009
Questions
(a) Explain the concept of an external shock and analyse two ways in which external
shocks can affect growth and inflation in an open economy such as the UK (10
marks)
(b) Using the data and your own economic knowledge, evaluate the policies that are
likely to be most effective in avoiding a sustained deflationary recession in the
UK economy (30 marks)