Economic Crises Flashcards
1
Q
Productivity Deficiency Post War (3)
A
- Productive efficiency of the economy at the micro-level was deficient post 1945, in comparison to the USA, West Germany, France and Germany.
- Comparing to countries with similar incomes levels post war, British growth 0.7% lower than others in the Golden Age, cumulating to an income shortfall of almost 20% by 1973 (Crafts).
- Crafts finds that the main cause beside the inefficient use of labour was government policy, namely the nationalisation experiments and competition policy. i.e. part of the cause of deficit was government mistakes.
2
Q
Stagflation during the 60s and 70s (6)
A
- Keynesian economics advocated the use of fiscal demand management to ‘cure’ this deficient growth, but its use worsened the economic conditions and brought about stagflation.
- When governments used expansionary policy to stimulate the economy, a by-product was high inflation, which required contractionary policy to eliminate it known as ‘stop-go’ macroeconomic policy.
- Result is stagflation, as detailed below. Fig 1 represents the theoretical relationship between unemployment and inflation in an economy, in a relationship known as the Phillips Curve. The expansionary phase of the cycle increases AD, meaning output is closer to the full employment level and hence unemployment is reduced. It is represented through the shift from A to B on Fig 1. However, the result is higher inflation, and workers will thus big up the nominal wage, to protect the real value of their wage, and so the SRPC undergoes a parallel vertical hike to SRPC2, such that the inflation rate at B correlates with the NAIRU. As the government continues with its expansionary policy, the economy then moves up SRPC2 to point D. Here, the economy is no longer experiencing high unemployment, but high inflation. So, the government enters the contractionary phase of the cycle, causing the economy to move down SRPC2 to point E. At point E, the economy is experiencing stagflation: higher unemployment and inflation relative to point A.
- Entirely caused by the stop-go cycle, which is a policy choice by the government due to Keynesian economics, which governments were ideologically committed to, being the predominant paradigm.
- In the 1970s, it was made even worse by the OPEC oil price hike.
- Stagflation was somewhat cured through Thatcher’s nationalisation policies, due to her strong belief in monetarism.
3
Q
Unemployment crisis in the 1980s (4)
A
- Unemployment in 1982 reached 3 million, much higher than the 1.5 million when Thatcher came to power and the 580,000 in 1970.
- Unemployment crisis was caused entirely by policy decisions of the Thatcher government. Thatcher’s key aim was to reverse Britain’s relative economic decline through an ideological shift away from government intervention and towards supply-side, free market based economics – involved the privatisation of many industries (BA, BT, BG, Rolls Royce) and the cutting of subsides to make them more efficient.
- Accepted that short term unemployment would be a necessary by-product of achieving this policy aim.
- Crisis was entirely caused by the government, it was a policy choice if anything.
4
Q
Exchange Rate Mechanism Crisis, 1990-92 (7)
A
- In 1987, stock markets crashed, and there was a real fear of a global recession.
- As such, Chancellor Lawson employed expansionary monetary policy in expectation.
- But recovery was much quicker than expected, and the monetary expansion proved excessive, leading to the ‘Lawson Boom’.
- Contractionary policy was employed to combat the high inflation. With Major now PM, his cabinet was able to push for the UK to join the ERM (something Thatcher was strongly against). The pound entered at the exchange rate of £1 = 2.95 Deutschmarks, which was an extremely high peg, but chosen to try and tame domestic inflation.
- However, to maintain this peg required extremely contractionary monetary policy, leading to a recession in the early 90s.
- When the pound came crashing out of the ERM in 1992, the pound lost value and interest rates fell, which paved the way for a strong export-led recovery.
- Once more, this crisis was entirely caused by policy ‘errors’, and thus it was easier to fix by a government.
5
Q
Great Recession (12)
A
- The sub-prime mortgage crisis in the USA ultimately caused the Great Recession of 2008.
- Deregulation in the US meant that there was greater freedom to create riskier, more profitable assets, which included the creation of mortgage-backed securities (MBS).
- This, coupled with governments implicit advocation of sub-prime loans (due to political pressure to counter rising inequality), meaned that a number of these mortgages were sub-prime – 59% of total loans were sub-prime in June 2008.
- However, despite being risky themselves, when they were packaged into a security, they were still being rated AAA since they contained a diverse range of securities.
- These packages were sold to investment banks all over the world, including Northern Rock, Royal Bank of Scotland and Halifax Bank of Scotland in the UK.
- Investment banks were now much more exposed to the US housing market, and when the housing bubble popped, house owners began defaulting on loans, and Investment Banks suddenly found themselves short in cash.
- Not only could homeowners not pay back on thier loans, but investment banks could not pay their debt either.
- A financial crisis was propagating through the US. Due to some UK investment banks being in possession of MBS, they too were affected, and Northern Rock and others sought financial support from the BoE.
- This caused a bank run, where panicked depositors feared they would not be able to withdraw savings if Northern Rock were to collapse. The bank collapsed, and there was no option but to take it into state ownership.
- Confidence in the economy plummeted, stocks crashed, AD severely weakened: recession.
- CAUSE: Out of the UK governments hands, entirely in the US. Only thing is UK deregulation. Took 25 quarters to return to pre-2008 levels, compared to 13 quarters for the crises in the 80s and 90s.
- Unemployment grew by 3% at its peak. UK GDP shrunk by 6% in 2008. Despite expansionary fiscal and MP, took a while because it was a balance sheet recession (firms weren’t spending, were only focused on paying off debt), shortage of credit and the productivity puzzle.
6
Q
Brexit (8)
A
- Vote in June 2016, Jan2020 - EU Withdrawal Agreement Act.
- Most obvious + direct impact - barriers to trade between UK and biggest trading partner - UK trade as proportion of GDP (‘trade intensity’) fell significantly (OBR), considerably more than other advanced economies.
- Challenged smaller manufacturing firms in particular.
- However, ONS data suggests that surprisingly services trade held up whilst goods was weak
- UK strength in service exports reflects UK’s strong position in high value sectors like consultancy (few barriers to trade).
- Investment already poor pre-Brexit - evidence suggests investment 10% lower than it otherwise would have been, particularly poor since 2016.
- May translate to reduction in productivity thus output of just over 1% of GDP - nowhere near as significant as financial crisis or Covid-19 - possibly could reflect Brexit uncertainty, in which case catch-up expected.
- Best estimate using synthetic counterfactual methodology finds 5% negative impact on GDP since vote to leave.
7
Q
Covid (4)
A
- December 2019/Jan 2020, Covid was discovered in Wuhan, China. It quickly spread around the globe, with governments declaring it a pandemic.
- In the interest of national health, lockdown was introduced in the UK in March 2020.
- Had disastrous effects on the UK economy: UK GDP contracted by 19.8% in Q2 of 2020, which represented a recession given that there was a fall by 3% in Q1, and unemployment increased slightly (4% to 5.1%) but would have been drastically more if not for the furlough scheme.
- Debt to GDP breached the 100% mark during the pandemic (highest since FY1962) and is still rising. Once more, the UK government had no direct control over the disease and its progression in Covid.
8
Q
Truss (10)
A
- Largest tax cuts in 50 years - aim to fix UK’s poor growth performance, but approach was too single-minded and abrupt.
- Focused on higher-income households (inc. scrapped 45p rate of income tax) - 45% of gains to richest 5% of households.
- Kwarteng - in order to be fiscally sustainable, £36bn of spending cuts would be needed 2026/27 - equivalent to total cut announced by Osborne 2010 budget
- Boosted growth in SR but yielded £411bn additional borrowing over 5 years (tax cuts cumulative cost £146bn)
- Actions cost the govt £30bn.
- Central govt debt interest payable £6.7bn Jan2023 - highest since monthly records began (1997)
- PSND 98.9% of GDP (£2.49tn)
- STRONG Parallel - Truss tax cuts largest since Anthony Barber’s ill-fated 1972 budget, to deal with growing unemployment and stagflation.
- BoE lending rose £71m - £1332m, 1971-73
- Also U-turn in policy - forced to end fiscal expansion due to inflation, OPEC oil price rise and Miners’ Strike
9
Q
Ukraine (6)
A
- Higher energy prices –> inflation - erodes real incomes, consumption - inflation caused by external factor so no wage growth to compensate
- Widespread impacts
a. ‘pump’ price of petrol and diesel (3.3% of basket)
b. retail energy prices - Ofgem price cap revisions raised typical bills by 54%
c. increased cost of producing other goods + services in proportion to energy intensity of production (remaining 46% of UK energy consumption) - Drag on demand from lower real incomes partially offsets upward cost pressures
- CPI peaked at 11.1% (Oct 2022) - war key reason that CPI remained above 2% - ‘cost-of-living crisis’
- Russia sanctions has reduced GDP to 0.5% below its projected growth in 2022 and 2023
- Parallel - 1973 OPEC oil crisis (also war-related Yom Kippur), oil supply constrained - led to inflation
