1. EC-111 British Economy
Recent UK Macroeconomic
Trends
Dr Catherine Robinson
F26, Richard Price Building
Office Hours: Mondays 10.30-11.30 and Thursdays 9.30-10.30
Appointments: c.robinson@swansea.ac.uk
2. Outline for this week‟s lectures…
Macro policy and the financial crisis
What caused the financial meltdown of 2007?
What were the consequences?
How to recover from the global recession?
Does this mean that existing macro models were inadequate?
Is the triple-dip recession likely? (TODAY WE FIND OUT)
Note the global nature of this week
In part a result of the problem
Also, increased globalisation means the UK cannot be
looked at in isolation
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3. What is a recession?
2 consecutive quarters of negative GDP growth
Caused by monetary policy being too tight
Policy response: loosen monetary policy
Lower interest rates
A DEPRESSION on the other hand:
A decline in real GDP that is greater than 10%
A recession that lasts more than 3 years
An asset/credit bubble bursting
Credit contraction followed by decline in price levels
Policy response:
Fiscal stimulus to encourage spending; infrastructure projects
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4. The Financial Crisis of 2007
The economic slow down began in 2006..and in the US
Relatively high risk borrowers in the US lost their jobs
Unable to pay their high monthly repayments
Interest rates were rising too because of the slowdown
Increased number of defaults led to concern about the
„sub-prime‟ market for loans
“The mother of all housing bubbles” (Krugman 2009)
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5. Contagion
By 2010, house prices (and share prices) in the US had
fallen by 29% from their peak in 2007
Reducing economic growth
Caused a big drop in UK inter-bank lending, with
knock-on effects on other sectors such as
manufacturing
Contagion
as there was more and more scrutiny on the lending
practices of financial intermediaries
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6. Causes: Financial
„innovations‟
The Big Bang led to deregulation…
Deregulation of the financial sector led to innovations in
products:
Short selling
Over the counter derivatives
Securitisation
Proprietary trading
Speculation
SHADOW BANKING
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7. Structured Investment Vehicles
(SIVs)
innovative ways to package debts
In such a way as to obscure the risks associated by
creating a portfolio of liabilities
some of which were the sub-prime mortgages
Some of which were short term debts (with comparatively
little risk)
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9. Realisation – followed by PANIC!
Early 2007:
saw 4 mortgage providers in the US file for bankruptcy
Reported that sub-prime lenders were 5 times more likely to incur
defaults
Bear Sterns lost 90% of its sub-prime loans and filed for
bankruptcy
August to November 2007:
More banks collapsed BNP PARIBUS froze investment funds
$300bn is pumped into the global system to maintain liquidity
Northern Rock collapses
Poor financial announcements in the US
Freddie Mac and Fannie Mae announce record losses
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10. And the bad news
continued…2008
Further write-downs and losses announced, interest rates
slashed to record low levels
Northern Rock nationalised
In July in the US Indy Mac Bank collapses, the second
largest bank failure ever
Lehman Brothers attempts to sell 50% of its shares to south
Korea or China. Fails. In September enters bankruptcy, the
largest in USA history
In the same month US Government takes control of Freddie
Mac and Fanny Mae
Merrill Lynch, Bank of America, Bear Sterns and Lehmann
Brothers have all by now ceased to trade
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11. Bank Bailout
Events unfolded in such a way as to the extent to which various
banks were exposed to the sub-prime market via these SIVs
Market sentiment ruled – investors panicked
Required de-leveraging; savings required to pay some debts
For the first time since Victoria‟s reign, there was a run on a UK
bank
Freddie Mac and Fannie Mae in the US were the initial lenders
Northern Rock in the UK
But all banks had some degree of exposure
Bank Bailout
Problem was, banks were so big, it wasn‟t always possible for
countries to save them
Aggressive, orchestrated policy required by US, UK and EU.
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12. Crisis management
Warren Buffett injected $5bn into Goldman Sachs
Lloyds rescues HBOS
US government provided $700bn to help banks recapitalise
Bradford and Bingley was nationalised in the UK
UK government saves RBS
US Fed paid $800bn to 21 US banks
UK Government announced £50bn to buy stakes and issue debt
guarantees (up to £250bn)
Record low interest rates
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13. So, the UK policy response
•To emphasise international co-operation and co-ordinated
fiscal and monetary policy responses to help move the UK
and world economies out of recession
•a number of levers during the recession:
Bank base rate reduced to 0.5 per cent
Bailing out of some banks and finance to support the balance
sheets of the banks
Value Added Tax temporarily reduced from 17.5% to 15%
Quantitative easing of £200billion – Asset Purchase Facility by
which the Bank of England can buy corporate bonds
Car scrappage scheme
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14. Into 2009…heading into
double dip…
But the market is still jittery (Flash crash of the NYSE in
May 2010)
International organisations meeting to define standards
in banking
BASEL III
Contagion means that currencies are suffering
Euro problems in Ireland, Greece and now Portugal and
Italy…
Cyprus problems in the news recently
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15. How can we ensure this mistake
doesn‟t happen again?
Regulate the financial sector more effectively
Commission a report – the Independent Commission on Banking
Sir John Vickers
Report published in September 2011
recommendations on ring-fencing domestic retail banking, 1/6th to
1/3rd of banking assets to be within the ring-fence
Competition in banking sector needs to be improved
“Future of Finance”, 2010
Report by LSE stars – Adair Turner, Andy Haldane and lots of
others
Highlights that central banks and governments should shoulder
some of the responsibility for the failure – argue as yet, this hasn‟t
happened
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16. Management of the financial
system
Increasingly understood that the financial system had
changed beyond recognition from the 1980s
Many banking investments were obscured, bordering
on illegal (Barclays fined £500m by the UK treasury)
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17. Why are banks regulated in the
first place?
Goodhart (2010)
Market failures:
Monopoly control
Asymmetric information
Externalities (social costs to bankruptcies)
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18. What has happened to our macro
variables?
Source: Gregg and Wadsworth
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19. International variations
• Gregg and Wadsworth (2010) group countries into 5
categories on the basis of changes in the GDP and
unemployment over the recession:
Those with small falls in employment relative to GDP (UK
and Sweden)
Those with small falls in employment relative to
GDP, having introduced employment subsides
(Italy, Germany, Netherlands and Japan)
Those with similar employment and GDP falls (France)
Those with larger employment falls than GDP (US, Spain
and Ireland)
Those with little fall in GDP (Australia)
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20. Why did the UK labour market hold
up?
Employers entered the recession in fairly good financial shape
Able to absorb some of the downturn without shedding jobs
Total hours worked have fallen sharply and the share of part-timers
risen
Workers accepted nominal wage moderation early on in the
recession
increased chances of finding work if they are made redundant
• The impact on productivity (and international competitiveness) and
public finances has been large; hence the cuts
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21. Cost of crisis
The level of debt in most Western Economies is a
direct result of bank bailouts
Severe recession
Bank of England policy of “quantitative easing”
Exchange rate system in Europe under threat
Greece most obviously
Irish IMF loan and the austerity measures
Italy, Spain and Portugal also under pressure
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23. And now the Euro…
Weaker countries within the Eurozone have suffered –
especially Greece
No longer considered to be a good debtor
Agreed to a range of austerity measures for the
foreseeable future in exchange for Euro bailout to prevent
national bankruptcy
A wider EU problem
The ECB issued €530bn of cheap loans for Banks to
ease liquidity concerns
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24. Failures of macro models?
How come no one saw this coming?
Well, some did (but not as many as now claim they did)
Housing market had been overvalued for years in the UK
Savings far too low
Did our macroeconomic models let us down?
Over-reliance on inflation targeting?
Argued that MONEY is a glaring omission from existing
new Keynesian macro models
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25. There will be other
mistakes…
Macroeconomic models will not cover all eventualities
Abstractions from the real world
Simplifications
BUT still powerful tools
A new focus on risk?
The role of credit ratings are also under scrutiny
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26. Road to recovery
Osborne:
Treat the recession
Tighten the fiscal belt – balance the budget
Reduce government spending – rebalance the UK economy
Encourage growth through private sector enterprise and growing
exports
Regulatory reform of the financial sector
Balancing the need for reform against the footloose nature of financial
intermediaries
Balls:
Treat the depression
Looser fiscal policy to encourage growth
Short term increase in government spending to get the economy back
on track
Tougher stance on financial sector reform
Is the second policy approach viable?
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27. References
Griffiths and Wall (2012) Applied Economics, Chapter 30 for the basics
Crafts and Fearon (2010) ‘Lessons from the 1930s Great Depression’, Oxford
Review of Economic Policy, 26(3), 285-317
Drinkwater, Blackaby and Murphy (2011) ‘The Welsh Labour Market
Following the Great Recession’, WISERD Policy Brief
A play by Julian Gough: goat futures explains the housing bubble
For up to date information, have a look at the Economist blog:
http://www.economist.com/blogs/blighty
Deeper understanding in the current debates going on:
Finance for the Future, LSE Report of 2010, available at
http://www.financeforthefuture.org.uk.
This is really tough stuff though, so just read the summary!
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