The Bank of England (BoE) raised interest rates from 2.25 per cent to 3 per cent on November 03, 2022 which is the highest rise since 1989. According to the BoE, the economy might already be in a recession which could last up to two years. The interest rates have been increased to control inflation which was 9.9 per cent in August 2022 and 10.1 per cent in September, the highest in the last 40 years. The BoE also forecasts that inflation might touch 11 per cent during the current quarter. A rise in inflation not only affects the prices but also reduces the real income of people.
Therefore, people experience their income adjusted to inflation to be very low. Unemployment is expected to rise steadily to 6.4 per cent by late 2025, which is presently 3.5 per cent. Most of the taxes cut by Liz Truss have been reversed. According to UK’s prime minister, Rishi Sunak, there would be a squeeze on public spending, the taxes might go up, and energy subsidies may be removed.
The growth rate of the UK in 2023 is predicted to be less than 0.3 per cent by the International Monetary Fund (IMF). Such a low growth rate is practically a negative growth rate in the face of rising inflation. In 2023, the economy of the UK is expected to shrink by 1 per cent, according to Goldman Sachs. According to a leading UK economic forecasting group, EY Item Club, the continued shrinking of the economy will result in a 0.3 per cent fall in UK’s GDP for 2023. When the GDP of a country falls for two consecutive quarters or 6 months, then the economy is said to be in a recession.
Causes of the Crisis
Some of the causes of this economic crisis are as follows:
Inflation The prices of gas increased exponentially especially due to the Russia-Ukraine War. Rise in gas prices was the highest in recent times. Besides, the supply-chain bottlenecks and labour shortages due to the COVID-19 pandemic also increased the overall price level.
Stagnant growth After the financial crisis in 2008, the growth of the UK economy has been low and inconsistent and could not digest the pandemic and its after-effects. Though it is recovering from the effects of the pandemic, the growth rate is still low.
Low investment According to the Office of National Statistics, the investment to GDP ratio of the UK was around 17 per cent in 2021 and 18.23 per cent in 2017, which is a lower percentage compared to the other developed countries. The reason could be the economic outlook of IMF about Britain is not very good. Ukraine crisis with Russia has deepened, and President Putin has threatened with nuclear strike. Similarly, OPEC countries have put a big question mark on the future of energy prices.
Brexit One of the reasons which increased the cost of living in the country and has reduced growth is Britain’s exit from the European Union. According to a think tank from the London School of Economics, Brexit has reduced the competitiveness of UK exports. After Brexit, the UK’s economy has become less open leading to low productivity and lower growth. The multinationals withdrew billions of dollars from British banks and transferred assets worth billions out of the country.
Political turmoil The former prime minister, Liz Truss, launched the tax cuts package which has had a negative response from investors. The policy was to increase long-term investments and growth. However, it resulted in a reduced level of sterling against the US dollar and increased cost of borrowing. The BoE had to compensate with the bond market to restore the sterling. Consequently, Liz Truss had to resign. Now, Britain has to take some stern and difficult decisions in order to resolve the crisis.
Implications of the New Policy
Rishi Sunak, has come with a new policy. This policy has the following implications:
Higher interest rates Increasing the interest rates to control inflation could lead to slower investment growth. As the interest rates keep on rising, the growth of business investment will be slow and will not be able to support the growth of the economy. This is true not only for the UK but also for the global scenario.
Imports If taxes are cut, it will result in the fall of the pound sterling. The lower value of the pound with respect to the US dollar will increase the cost of imports. UK’s economy is heavily dependent on other countries for oil, and low sterling value will increase the burden of oil imports even further.
Investor confidence If the government fails to establish trust among the investors in the present scenario, the investors will lack confidence and will not be willing to lend money. Consequently, the government bonds in the UK will increase.
Inequality between the top and lower sections Generally, the tax cuts or the increase in interest rates are done to spur investments by saving the top income layers of the economy. The assumption is that if the top sections of the economy are saved and protected, the lower sections will also have the benefit of the trickle-down effect. But in the present scenario, this strategy may not work. If inflation continues, top sections of the economy may remain saved but the lower sections will have to face the increased cost of living, higher unemployment, and lower incomes. Thus, inequality may further rise. In reality, the tax cuts policies were not very well received. They were compared to Ronald Regan’s (former US President) policies.
Apart from the above, the situation in Britain is also worsening due to its debt. To increase investment, borrowing from foreign sources increases the current account deficit leading to decrease in the value of the pound sterling or increases the interest rates to control inflation or a combination of both of them. With a new prime minister and new policies, the best possible outcome is to limit the extent of the recession, prevent a crisis, and get back on the growth track with an improved cost of living.
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