Table of Contents

  • The world economy was hit by a succession of shocks during 2007 and 2008. The United Kingdom, like most OECD economies, is experiencing a severe economic downturn, and there is enormous uncertainty about the macroeconomic outlook. Since the peak, GDP has contracted by 4.2% in real terms and is projected to contract further, with a decline of 4.3% expected in 2009. Lower house prices and the slump in equity prices will depress household consumption, together with rising unemployment and weak consumer confidence. Business investment will decline owing to the challenging prospects and tight financial conditions. While sterling has depreciated by around 20% in effective terms since 2007, exports will decline due to the sharp fall in external demand. However, imports are expected to fall faster meaning that net exports will contribute positively to growth. The unemployment rate is rising sharply and could be close to 10% by 2010. Monetary and fiscal stimulus, the weaker exchange rate and some recovery in foreign demand should promote a recovery during 2010. But, this will depend critically on whether measures to stabilise the financial system are effective. Even if they succeed, growth is expected to remain well below trend as households and firms rebuild their balance sheets. The passthrough of higher import prices will slow the decline in inflation in the early part of 2009 but the weakness of demand will create substantial spare capacity in the economy, which will lead to inflation well below the official target for some time. The extent of the global downturn on activity is unclear. A slower than anticipated return to normal financial conditions would have a negative impact on the economy. Greater than anticipated declines in house prices could weigh further on consumption and increase the feedback by exerting further pressures on banks’ and households’ balance sheets. Significant monetary and fiscal policy stimulus is in place, and although it may not prove as effective as hoped, it is possible that the policies will have a faster and stronger positive effect than anticipated.

  • The United Kingdom, like many OECD economies, is experiencing a severe recession as a consequence of a series of global shocks and any recovery in 2010 is likely to be slow. The financial crisis has severely impaired the supply of credit and house prices have fallen sharply. Unemployment is expected to increase significantly. The large rise in the government deficit is providing support to demand, but the debt-to-GDP ratio will increase substantially. Room for additional fiscal stimulus is therefore limited. Monetary policy has eased and the policy rate has fallen to close to zero. However, the monetary transmission mechanism is impaired and financial conditions while improving somewhat remain restrictive. The Bank of England has begun quantitative easing measures, although these are more likely to be effective within a more transparent framework. Normal functioning of the financial system is necessary for the economy to recover and the authorities have implemented a wide range of measures to support the financial sector. These measures have helped to stabilise the financial system. Given the cyclical rise in unemployment, it will be a significant challenge to ensure that joblessness does not become entrenched, even if the UK labour market is relatively flexible.

  • As in most other OECD countries, the fiscal situation in the UK has deteriorated sharply. While to date the discretionary fiscal stimulus has been relatively modest, after around the turn of the century the underlying fiscal position weakened more than anticipated. While there was some subsequent improvement, particularly in tax receipts, the severe impact of the downturn on the public finances and the borrowing related to the rescue of the financial sector will take public debt to levels in line with or even exceeding other European economies. The government has set out a commitment to bring the cyclically-adjusted current budget back in balance and ensure debt is falling as a proportion of GDP once the economy is recovering, and has announced fiscal consolidation plans worth over £ 50 billion. The government needs to ensure it delivers on its commitment to implement a sustained consolidation. While the Code of Fiscal Stability provides the foundations for a sound fiscal framework the government should consider reformulating the fiscal rules once uncertainties have reduced. Any reformulation should provide for expenditure discipline, and be forward looking. The current temporary operating rule that was put in place with the suspension of the fiscal rules in the November 2008 PBR is forward looking in this way.

  • The UK financial market has been severely affected by the financial market crisis. The crisis has exposed weaknesses in the supervisory framework as well as that for crisis management and resolution. This chapter reviews the supervisory and regulatory framework and the many reforms that have already been adopted to remedy these weaknesses. It also provides recommendations for further reforms.

  • While the immediate imperative is to tackle the financial crisis and to steer the economy through the current downturn, there are also a number of longer-term challenges that need to be addressed to foster a robust and sustainable recovery. In particular assistance for young and low skilled workers needs to be enhanced and the performance of the education sector also needs to be improved.