The Global Economic Crisis and UKMacroeconomic Policymaking
Extract A
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 ofexternal 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)