Print Email Download Reference This Send to Kindle Reddit This
submit to reddit

Discuss the impact and effectiveness of the key economic policy measures taken by the UK authorities in response to the UK recession of 2008-9.

INTRODUCTION

The relationship between Gross Domestic Product of a country and the price level is known as the Aggregate Demand (Please see Appendix 1). A recession is defined by decrease in GDP over two consecutive quarters. During recession, the aggregate demand falls below the desired level of the full-employment output. In the UK, there has been a 0.4% drop in the GDP (contrary to the expectations of a 0.2% increase) in the third quarter of the 2009 (Seager et al. 2009) (Please see Appendix 2, Pt.1, Pt.2) and currently there are 2.5 million people unemployed (Kirby 2009).

Fundamentally, there are two approaches that can be taken to influence the Aggregate Demand through policy changes, namely the Fiscal Policy and the Monetary Policy. These policy changes are expected to smoothen out the business cycle (University of Colorado at Boulder 2009).

Fiscal Policy approach uses the change in government spending and taxation to influence the Aggregate Demand (Please see Appendix 1). To increase the Aggregate Demand, either the government spending or the consumer spending can be increased. The government can invest money into sectors such as construction, healthcare and education resulting into creation of jobs. Alternatively, the taxes can be reduced to create disposable income for the consumers to increase the consumer spending (pajholden 2008).

In contrast, Monetary Policy allows the central bank to control supply, availability and cost of money (interest rate). By doing so, the central bank can influence to what extent companies can borrow, how much money there is in circulation and the cost for short term borrowing. This is targeted to keep a check on the rate of inflation to ensure a steady growth. By buying or selling bonds, the central bank can, respectively, increase or decrease the amount of cash in circulation. By setting up interest rates at which the other banks borrow from the central bank, the interest in the overall economy can be increased or decreased. If the interest rates for borrowing are lower, the borrower banks can lend at a lower rate enabling companies to fund their growth easily. (Fischer 2008)

THE GOVERNMENT ACTION

In order to combat the current crisis and bring stability to the financial system, the UK government, HM Treasury, Financial Services Authority and the Bank of England have taken unprecedented measures during 2008 and 2009.

Bank Recapitalisation Programme: This programme was used to ensure that the banks have enough capital against their loans to continue lending to businesses and consumers. £37 billion funds were used to support Royal Bank of Scotland, Halifax Bank of Scotland and Lloyds TSB. Banks supported by the government in this fashion have been entrusted to offer loans at competitive interest rates to the homeowners and small enterprises (HM Treasury 2008) [1].

Special Liquidity Scheme: Launched in April 2008 to ease up the credit crunch, the purpose of this scheme was to promote lending among banks and building societies (Oxlade 2009)[1] enabling them to trade assets that cannot readily be converted into cash in exchange for UK Treasury Bills for a limited time (Bank of England 2008)[1]. Initially intended to run until October 2008, it was extended until January 2009. £185 billion worth assets were traded under this scheme (Oxlade 2009) [1]. 32 banks and building societies participated in this scheme (Monaghan 2009).

Guarantee Schemes: Currently, two such schemes are operational, namely, 2008 Credit Guarantee Scheme and 2009 Asset Protection scheme, to safeguard ordinary savers, borrowers and businesses (UK Debt Management Office 2009) [1].

The purpose of the Credit Guarantee Scheme was to guarantee borrowing by qualifying banks and building societies in exchange of a commercial fee. It was launched in Oct 2008 to run over a 3 year period and in December 2008 was extended until April 2014, so that the participating institutions are able to manage their transition from ‘guaranteed funding' to ‘entirely unsupported funding'. The fee charged to ensure proper tax payer remuneration was reduced in December 2008. The taxpayer liability estimated by the government was £250 billion (HM Treasury 2008) [2].

The Asset Backed Securities Guarantee is an extension to the Credit Guarantee Scheme. It is aimed at facilitating the lending in the economy by the banks and the building societies, by improving their access to the wholesale funding market through the Credit Guarantee Scheme (UK Debt Management Office 2009) [3].

The Asset Protection Scheme: Launched in February 2009, the Asset Protection Scheme is meant to support banks with historical bad debts. These banks not comfortable with the idea of any further lending are insured by the government against any further losses hoping that they start lending to firms and households. For any future bad debts, banks' losses will be limited (Seager 2009).

Interest Rates: Changes in the interest rates influence the investment spending and also the consumption. Initially, in October 2008, the interest rates were reduced from 5% down to 4.5% and later in March 2009, in a coordinated move with other central banks, down to a record low of 0.5% and have remained the same throughout a period of more than eight months (Monaghan 2009).

Asset Purchase Facility: Set up in January 2009, Asset Purchase Facility is aimed at improving the flow of credit between banks. With this facility, the Bank of England was authorised to buy high-quality private sector assets by issuing Treasury Bills. It also provides an additional tool for implementing the monetary policy. In March 2009, the Monetary Policy Committee decided to start using the Asset Purchase Facility in addition to the newly set interest rate of 0.5% to attain the inflation target of 2%. The purchases in this case are made by using newly created money. This way, the money is injected directly into the economy (HM Treasury 2009) [3].

Quantitative Easing: This measure has been brought in as the bank interest rate is closer to zero and any further reduction cannot influence the market interest rates, the aggregate demand or the inflation. Through this programme, the Monetary Policy Committee intends to boost the money supply in the system by giving banks extra capital by buying long term government debts and corporate bonds to ease up pressures on the banks. These assets are paid electronically by crediting the accounts of the companies as opposed to printing actual currency notes (Bank of England 2009) [2]. The programme was extended from £175 billion to £200 billion (BBC 2009).

Car Scrappage Scheme: In order to give a boost to the automotive sector, the Vehicle Discount or Car Scrappage scheme was launched to run from May 2009 to February 2010 to cover 400,000 vehicles. The government set £400 million aside for the same. It is a voluntary scheme for vehicle dealers. The dealers are supposed to give a £2000 discount if consumers let their ten year old vehicle be scrapped while buying a new one (UK Government 2009). The £2000 discount is offered half by the government and half by the industry (Monaghan 2009).

IMPACT AND EFFECTIVENESS OF KEY POLICY MEASURES

Through £37 billion bank recapitalisation in 2008, the health of the financial institutions was restored, however, the public borrowing in the first half of 2009 financial year increased to £77.3 billion. This is the highest half yearly firgure since Second World War (Chapman 2009). As announced on Nov 3, 2009, another £38 billion will be put in RBS and Lloyds. In return, RBS and Lloyds will have to sell off 318 and 600 branches, respectively. The taxpayers' stake in Lloyds will remain at 43% and rise to 84% in RBS. According to the government, structural changes to these banks will allow their objectives on financial stability and banking reforms to be achieved at a lower cost to the taxpayer (Treanor 2009) and most importantly, it is part of the step to bring more competition back into the UK high street banking market (Lord Myners 2009).

The programme could potentially lead to an increase of £1.5 trillion to UK national debt, equivalent to entire country's one year output. With this addition, the total national debt could be £2.3 trillion. As per the Office for National Statistics, this is due to the enormous debts of the bailed out banks. The costs of implementation of the Bank Recapitalisation measures alone have been calculated to be £8 billion (Hall 2009). Taxpayers' investment in banking systems has crossed £1 trillion which includes guarantees and spending (Rogers 2009). (Please see Appendix3)

QE has helped reduce cost of borrowing, but there has been only slight improvement in the money supply in the economy in the third quarter of 2009 (Please see Appendix 2, pt.3). £175 billion were used to buy government bonds and the Bank may start buying the corporate bonds. LIBOR (London Inter-Back Offered Rate), at which banks lend to each other in the London wholesale money market, is a measure of the trust among the banks. The more the gap between the base rate and Libor, less is the money with the banks that they can lend, leading to banks increasing their rates and vice versa. (Please see Appendix 2, pt.4) With the injection of £40 billion into banks on October 13, this gap appears to have been reduced (Oxlade 2009) [3].

Despite the historic low interest rates, the inflation remained lower than the target. However, the Consumer Price Index rose from 1.1% in September 09 to 1.5% in October 09. The Retail Price Index rose from -1.4% in September to -0.8%. This sudden jump of inflation has been caused by the sharp rise in transport fuel and second hand car prices (Office for National Statistics 2009).

The Car Scrappage Scheme has been a success with a 31.6% increase in the automotive industry during October 2009 compared to last year. This increase is the biggest since 1999. Although a 2.5% VAT increase of next year seems to have influenced consumer buying decisions. This could be true especially in the cases of expensive cars (Millward 2009).

CONCLUSION

Theoretically, the multiplier effect of fiscal measures is difficult to predict. Increased government spending can give rise to increased consumer spending. However, there is a possibility that the disposable money may either be saved or leaked out of the country. Thus, it is difficult to achieve the desired effect with precision.

Quantitative Easing has never been tried before in the UK. Experts seem to have a divided opinion on the extent of QE that could effectively propel the economy. It is hard to estimate how soon the injected money will start flowing in the credit markets and it may take months before the desired effects can be noticed. If the financial institutions manage to hold on to their freed up money for some time before letting it flow into the economy, it can cause delays to the policy objectives from being met within the expected time frame.

The measures have been constantly intensified. The pound when weaker could help UK's export business. The inflation on the other hand has seen a sudden jump in October 2009. If it keeps rising at the same rate, it can soon cross the government's 2% target. In that case, the government may increase the interest rates. However, if the money which has been pumped into the economy is in excess, it could make it difficult to control the rising inflation.

The automotive sector was saved by the Car Scrappage Scheme which in turn might have helped save many jobs. However, the unemployment in the country remains to be one of the main issues as it has increased from 1.7million people at the start of 2008 to 2.5 million at the start of fourth quarter of 2009. This means that the amount of money being paid out as unemployment benefits is increasing. About 50% of UK's population works for SMEs. Looking at the significant rise in the unemployment, it seems that so far, finances have not been made available to SMEs, effectively.

UK being one of the most globalised countries has a major role to play in the global economy. Looking at the scale of global financial crisis and the loss of confidence in the banking system, the mixed policy measures taken by the British Government seem logical; however, due to constantly mounting national debts the payback for many years ahead seems inevitable.

APPENDICES

Appendix 1

AD = C + G + I + (X-M)

Where -

AD - Aggregate Demand

C - Consumer Spending

G - Government Spending

I - Capital Investment

X - Export

M - Import

Appendix 2

1. GDP Growth

Published on 23 October 2009 at 9:30 am by Office for National Statistics website

2. Unemployment rate

Published on 23 October 2009 at 9:30 am by Office for National Statistics website

3. The Money Supply in the Economy

M4SA.GIF

Source: Bank of England

4. Libor

Source: BBA

5. Inflation

Source: Office for National Statistics

Appendix 3. British government spend on the banking collapse

Date

What Happened

Potential Cumulative Total £bil

Amount

£bil

Notes

14/9/07

Northern Rock

25

25

£14 bil paid back

29/9/08

Bradford & Bingley

67

42

8/10/08

Special Liquidity Scheme

267

200

£100bn drawn on

8/10/08

Credit Guarantee Scheme

567

300

8/10/08

Bank recapitalisation plan

604

37

£20bn RBS, £17bn HBOS+Lloyd TSB

3/12/2008

Homeowner mortgage support scheme

605

1

13/1/09

Working capital scheme for SMEs

615

10

13/1/09

Enterprise finance guarantee

616

1

13/1/09

Capital for enterprise fund

616.05

0.05

19/1/09

Corporate debts

671.05

55

24/2/09

Bank losses covered

996.05

325

RBS £325bn (Lloyds prev had £260bn guarantee but now out of scheme with rights issue)

26/2/09

RBS Further recapitalisation

1021.55

25.5

3/11/09

Bank Recapitalisation/guarantee

1059.55

38

Lloyds - £6bn, RBS £32bn (£25bn + £7bn contingency)

Source: http://www.guardian.co.uk/news/datablog/2009/nov/03/bank-bailouts-uk-credit-crunch# (Nov 12)

REFERENCES

[1]Bank of England., 2008. SPECIAL LIQUIDITY SCHEME: INFORMATION, Page1, [online], Bank of England. Available from: http://www.bankofengland.co.uk/markets/sls/sls-information.pdf [Accessed 4 Nov 2009]

[2]Bank of England., 2009. Quantitative Easing Explained, [online], Bank of England. Available from: http://www.bankofengland.co.uk/monetarypolicy/assetpurchases.htm [Accessed 5 Nov 2009]

BBC., 2009. Q&A: Quantitative easing, [online], BBC. Available from: http://news.bbc.co.uk/1/hi/business/7924506.stm [Accessed 5 Nov 2009]

Chapman J., 2009. King: Debt mess will take decades to clear, [online], This is Money. Available from: http://www.thisismoney.co.uk/news/article.html?in_article_id=492195&in_page_id=2 [Accessed 8 Nov 2009]

Fischer M., 2008. E5. Introduction to Monetary Policy, [online], retrieved 3 November 2009, from: http://www.youtube.com/watch?v=MfKejMGEuxg

Hall M., 2009. BROWN'S BANK BAIL-OUT SENDS DEBT SOARING TO £92,000 FOR EACH FAMILY, [online], Daily Express. Available from: http://www.express.co.uk/posts/view/138740/Brown-s-bank-bail-out-sends-debt-soaring-to-92-000-for-each-family-

[1]HM Treasury., 2008. Bank Recapitalisation Programme, [online], HM Treasury. Available from: http://www.hm-treasury.gov.uk/press_126_08.htm [Accessed 4 Nov 2009]

[2]HM Treasury., 2008. Changes to Credit Guarantee Scheme, [online], HM Treasury. Available from: http://www.hm-treasury.gov.uk/press_138_08.htm [Accessed 8 Nov 2009]

[3]HM Treasury., 2009. Asset Purchase Facility, [online], HM Treasury. Available from: http://www.hm-treasury.gov.uk/uk_asset_purchase_facility.htm [Accessed 3 Nov 2009]

Kirby S., 2009. Recession and unemployment: the worst is yet to come, [online], The Times. Available from: http://business.timesonline.co.uk/tol/business/economics/article6885279.ece [Accessed 3 Nov 2009]

Lord Myners., 2009. New Labour p another £30bn of taxpayers up a wall (03Nov09), retrieved 12 Nov 2009, from: http://www.youtube.com/watch?v=6-fAhsuA1KU

Millward D., 2009. Biggest rise in car sales in 10 years, [online], The Telegraph. Available from: http://www.telegraph.co.uk/motoring/news/6507022/Biggest-rise-in-car-sales-in-10-years.html

Monaghan A., 2009. Britain is still in recession: the emergency measures propping up the economy, [online], The Telegraph. Available from: http://www.telegraph.co.uk/finance/financetopics/recession/6413156/Britain-is-still-in-recession-the-emergency-measures-propping-up-the-economy.html [Accessed 6 Nov 2009]

Office for National Statistics., 2009. Inflation CPI inflation 1.5%, RPI inflation -0.8%, [online], Office for National Statistics. Available from: http://www.statistics.gov.uk/cci/nugget.asp?ID=19 [Accessed 17 November 2009]

[1]Oxlade A., 2009. Special Liquidity Scheme, [online], This is Money. Available from: http://www.thisismoney.co.uk/jargon/S/special-liquidity-scheme [Accessed 4 Nov 2009]

[2]Oxlade A., 2009. Credit Guarantee Scheme, [online], This is Money. Available from: http://www.thisismoney.co.uk/jargon/C/credit-guarantee-scheme [Accessed 4 Nov 2009]

[3] Oxlade A., 2009. Libor rate latest, [online], This is Money. Available from: http://www.thisismoney.co.uk/libor (Nov 11)

pajholden., 2008. fiscal policy and the multiplier effect, [online], retrieved 3 November 2009, from: http://www.youtube.com/watch?v=0CjNlyiDAno&NR=1

Rogers S., 3 Nov 2009. UK bank bailouts in full. What else could you get for £38bn?, [online], The Guardian Datablog. Available from: http://www.guardian.co.uk/news/datablog/2009/nov/03/bank-bailouts-uk-credit-crunch# [Accessed 10 Nov 2009]

Seager A., 2009. How many bucks can you pass?, [online], The Guardian. Available from: http://www.guardian.co.uk/business/2009/mar/07/asset-protection-scheme [Accessed 6 Nov 2009]

Seager A., Kollewe J and Hopkins K. 2009. UK economy in its longest recession on record, [online], The Guardian. Available from: http://www.guardian.co.uk/business/2009/oct/23/uk-economy-lonest-recession-record [Accessed 3 Nov 2009]

Treanor J., 2009. Darling defends bank reforms and £39bn infusion as good value, [online], The Guardian. Available from: http://www.guardian.co.uk/business/2009/nov/03/banking-bailouts-lloyds-rbs [Accessed 12 Nov 2009]

[1]UK Debt Management Office., 2009. Guarantee Schemes, [online], UK Debt Management Office. Available from: http://www.dmo.gov.uk/index.aspx?page=CGS/CGSIntro [Accessed 4 Nov 2009]

[2]UK Debt Management Office., 2009. 2008 Credit Guarantee Scheme, [online], UK Debt Management Office. Available from: http://www.dmo.gov.uk/index.aspx?page=CGS/CGS_about [Accessed 4 Nov 2009]

[3]UK Debt Management Office., 2009. 2009 Asset-backed Securities Guarantee Scheme, [online], UK Debt Management Office. Available from: http://www.dmo.gov.uk/index.aspx?page=CGS/ABS_about [Accessed 4 Nov 2009]

UK Government., 2009. The vehicle discount scheme - money off your new vehicle, [online], UK Government. Available from: http://www.direct.gov.uk/en/Motoring/BuyingAndSellingAVehicle/AdviceOnBuyingAndSellingAVehicle/DG_177693 (Nov 5)

University of Colorado at Boulder., 2009. The Business Cycle, Aggregate Demand and Aggregate Supply, [online], University of Colorado at Boulder. Available from: http://www.colorado.edu/Economics/courses/econ2020/section7/section7.html [Accessed 3 Nov 2009]

Print Email Download Reference This Send to Kindle Reddit This

Share This Essay

To share this essay on Reddit, Facebook, Twitter, or Google+ just click on the buttons below:

Request Removal

If you are the original writer of this essay and no longer wish to have the essay published on the UK Essays website then please click on the link below to request removal:

Request the removal of this essay.


More from UK Essays