Hello readers, welcome back to my blog. This time I thought I would discuss the idea of economic booms and recessions (‘The Economic Cycle’)-an important concept in Economics with a specific focus on the UK economy. My last post was quite topical and relevant to the UK’s current situation. This post will focus more on the UK’s economic history to provide a background understanding as well as discuss the concept of the boom and bust cycle. I will summarise the information across two tables so that it is easier to interpret and process the information as well as make comparisons.
A diagram showing the Economic Cycle within a typical economy and the stages that it oscillates through:
Boom period in the UK
An economic boom is a period of rapid economic expansion resulting in higher GDP, lower unemployment and rising asset prices. One example of an economic boom period in the UK was the post world war II economic boom which led to the sustained period of economic growth and near full employment until the late 1970s, where it was inevitably followed by a recession (boom and bust cycle). This growth saw rising real incomes, which in turn led to higher tax revenues and falling debt to GDP ratios.
|Causes of Boom||Effects of Boom|
|Rapid global economic growth, especially in Western Europe, caused by recovery of Japan and Germany, low global inflation, increased free trade, with reduction of tariff barriers and relative political and economic stability. Also major technological improvements, such as computers, better petrol engines, and containerization.||This led to more jobs being created, falling unemployment and higher real wages. There was also a fast growth in consumption helped by rising real incomes, strong confidence and a surge in house prices and share prices. Government tax revenues increased as people earned and spent more and companies made larger profits – this gave the government money to increase spending in areas such as education, the environment, health and transport. Led to overall improved standard of living (SOL) and quality of life (QOL).|
|Immigration and rebuilding of infrastructure
UK growth was so rapid, it experienced labour shortages. This led to the mass immigration of the 1950s and 60s to help deal with the labour market shortages. This helped increase the working population and increase real GDP. Also damaged infrastructure from the war was rebuilt.
|More people working and generating more income in taxes for the government. Business with a greater labour force could expand to meet the rising demand and increase profits. Rebuilding of infrastructure led to increased spending on raw materials. Although the government spent high amounts of money on this, in turn it led to economic growth. Infrastructure projects also created jobs and more opportunities for people of all abilities.|
In the post-war period there was a growth in university education and secondary education became more comprehensive.
|This created new types of jobs in the services sector, which paid more, leading to higher incomes.|
|Higher levels of confidence and high ‘animal spirits’, between firms and business||A pick up in demand for capital goods as businesses invested more in extra capacity to meet strong demand and to make higher profits (accelerator effect)
|Worsening of balance of paymentsand trade deficits||High demand for imports because the country could not supply all of the goods and services that consumers were buying. Caused the economy to run a larger trade deficit. An increase in inflationary pressures if the economy overheats and has a positive output gap. This is the increase in the general price level, and this affected lower income families, as basic items had increased in price.|
Recession period in the UK
A recession is a period of economic decline resulting in lower GDP, higher unemployment and falling asset prices. It is often defined as two consecutive quarters of negative growth. An example of a period of economic recession in the UK was in 2008-2009, which was known as the Great Recession. According to the UK Office for National Statistics (ONS) the UK entered a recession in Q2 of 2008, and exited it in Q4 of 2009. It was the deepest UK recession since the war and affected many sectors including banks and investment firms, with many well known and established businesses having to close and declare bankruptcy.
|Causes of Recession||Effects of Recession|
|The global financial crisis of 2007-2008 and the subprime mortgagecrisis.
Sub-prime mortgages: these are a type of mortgage characterised as being taken on by a borrower with a low credit rating and often secured on a low value property. Lenders will charge higher interest rates than for conventional mortgages as they seek to compensate for carrying higher risk).
|The immediate trigger of the crisis in the UK was the bursting of the U.S.A. housing bubble, which peaked in 2004.
As banks in the USA began to give out more loans to potential homeowners, housing prices began to rise. However these were sub-prime mortgages and eventually when the bubble burst and houses prices fell, it resulted in homes being worth less than the mortgage loan, leading to lots of negative equity, creating a negative wealth effect and overall ‘low animal spirits’ providing a financial incentive to enter foreclosure. As the US dollar is the global currency for all commodities and as the US economy impacts the rest of the world as a result of, this caused economic turmoil in the UK too.
UK mortgage lenders also gave out subprime mortgages although did not lend so many bad mortgages and it still had more controls in place than the US. Despite this it caused very serious problems for Northern Rock brank. Northern rock had a high % of risky loans, but also had the highest % of loans financed through reselling in the capital markets (long term investments, and bonds). When the sub-prime crisis hit, Northern Rock could no longer raise enough funds and eventually had to make the humiliating step to asking the Bank of England for emergency funds. Money from the taxpayer was also used to fund this. As a result of this the Bank it caused customers to start to worry and they withdraw their savings (even though savings weren’t directly affected).
|Credit Crunch||Sudden shortage of funds for lending since the markets had dried up resulted in a decline in loans available.|
|A fall in purchases of components and raw materials||As a result of being unable to borrow, overall confidence in manufacturing and within firms was low and there were high levels of uncertainty, leading less confidence and no further investment.
As there was less demand for materials and products, it created lots of unemployment and fewer job vacancies available for people looking for work. By end 2008 the Manufacturing output had declined by 7%.
The unemployment rate rose to 8.3% (2.68m people) in August 2011, the highest level since 1994.
|A rise in the number of business failures and businesses announcing lower profits and investment
|As interest rates had been raised (at 5%) it meant that any loans businesses had were likely to have risen. Together with a contraction in sales because of little consumer confidence and spending led to lower profits and many companies being unable to survive. The whole financial crisis also impacted the value of exports and imports of goods and services hence affecting growth|