Impact Of Global Financial Crisis On UK Economy Essay.

Background of the Global Financial Crisis

Question:

Discuss about the Global Economic Crisis Causes and Consequences.

The purpose of this report is to explain about the impact of global financial crisis (GFC) in the UK economy that started in US during the period 2007 and 2008. The GFC that began in 2007 with the crisis occurred in the market of subprime mortgage in the US, which then developed into international banking crisis.  In fact, the investment bank named as Lehman Brothers collapsed during this period. Huge risk-taking by the US banks including Lehman Brothers facilitated in magnifying financial impact globally. At the epicenter of GFC, there was huge tensions around the globe, the Federal Reserve in US brokered deal that permitted JP Morgan in acquiring Bear Stearns (Berkmen et al. 2012). In addition, the Lehman Brothers that has been filed for the bankruptcy security also followed by radical losses in their stocks as well as assets devaluation.  Palliative monetary as well as fiscal policies had been implemented in order to prevent collapse of global financial system. This financial crisis led to downturn in the economy not only in the US but also in other nations worldwide. The effect of the GFC on the UK economy was larger than few other nations because of some particular factors. This financial crisis hugely affected on the housing market of UK. The prices of the houses have increased at high rate during the year 2008. Therefore, with rising trend in the values of property since deregulation, the markets of mortgage became highly profitable as well as attractive to all the banks in the global world. As a result, UK experienced decrease in manufacturing activities and rise in rate of unemployment in the labor market. Even the global export of products and services of UK declined at high rate (Cowling, Liu and Ledger 2012). Moreover, this GFC adversely affected in this nations trade and thereby the government of UK protected local industries that issued protection policies in reducing imports. This also led to decrease in imports of UK during this period.

The main causes of this GFC were due to credit crunch as well as housing bubble. The primary cause of the GFC during the period 2007 -2008 was due to deregulation in financial sector. This allowed the banks in engaging in trading hedge fund with derivatives.  However, the banks then demanded large mortgages for supporting sales of the derivatives.  They even created interest on loans and this benefitted the subprime borrowers as it became affordable to them. The main causes of GFC during the period 2007-2008 are illustrated below:

Impact of the Global Financial Crisis on the UK Economy

The GFC has commonly believed to have started in 2007 with the crunch in credit when the confidence loss of the investors in US in sub-prime mortgages value resulted in liquidity crisis. This led the federal bank in US to invest huge amount of funds into the financial markets. As a result, the crisis worsened owing to high volatility of stock markets in the globe (Chor and Manova 2012). The crunch in credit defines as the sudden funds shortage for lending, which leads to decrease in availability of loans. Credit crunch occured due to several reasons, which includes-

• Sudden rise in rate of interest
• Direct control of money by the respective economy’s government
• Scarcity of funds in capital market

In US, the housing market suffered largely because several homeowners had pulled out their subprime mortgage loans as they had less ability in meeting their mortgage reimbursement. This was triggered by decrease in the prices of houses after crumpling of housing bubble. This lead to delinquencies of mortgage and devaluation of securities that is related to housing. In addition, the competitive pressures as well as few government regulations had led to rise in subprime lending amount during this period. The value of subprime mortgages in US was recorded at $1.3 trillion during the  year 2007, with near about 7.5 million outstanding first-lien subprime mortgages. Moreover, the decrease in household investment preceded recession, which further led to decrease in household expenditure and business investment. Moreover, the borrowers had negative equity as the residence value plummeted. As numerous borrowers defaulted on their loans, the banks in US faced bad condition because the repossessed residences were worth less in that market. Even the banks had huge crisis of liquidity and thus receiving housing loans became highly difficult due to fallout from this lending of subprime mortgage loan. Reduction in expenditure was vital in this sector due to decline in high residential debt as well as residential price. Therefore, collapse of residential market in US had triggered to GFC.

The GFC during the period 2007-2008 had increased the rate of unemployment in UK from 5.1% in 2008 to 9% in 2012. From the figure below, it has been revealed that, the rate of unemployment was floating between the range of 4.3% to 6% during the period of GFC. Furthermore, it increased to 8% rate within this period and this further worsened to 8.4% in 2011.

From the Office for National Statistics (ONS), it has been noted that the unemployed person in this nation increased from 48,000 to 2.7 million during the period of 2007-2008. Several jobs were lost in some top companies and the banks in this nation have either collapsed or merged as a result of GFC. However, the workers who have lost their jobs faced huge difficulties in finding another job as the firms stopped their recruitment during this period. There were not enough places for job for filling up the job seekers.  As a result, this declined the standard of living of these unemployed workers (Choudhry, Marelli and Signorelli 2012). Several young persons of this nation preferred to remain at home based on claiming benefits of joblessness rather than opting for another job that would actually raise the saddle of UK government deficit. Besides this, the GFC had also adversely affected both the small and large companies. Loss of jobs of some workers declined the total productivity of the business. There are few other reasons that led to slowdown in total productivity since GFC that includes- misallocation of resource among the present companies, drop in entrance of new firms and scarcity in innovative destruction of firms (Tanveer Choudhty, Marelli and Signorelli 2012). As a result, the financial performance of these companies decreased during this period. Hence, the fall in rate of unemployment in the UK economy adversely affected the GDP (Gross Domestic Product) of this nation.

Causes of the Global Financial Crisis

Following the GFC in 2008, the banks in UK lending to businesses declined significantly. The manufacturing sector in UK suffered large blow from GFC. According to the data released by office of national statistics, it has been noted that even after the financial crisis, the total output of the manufacturing sector dipped below 2%.

There has been huge change in nature of housing market in UK due to this GFC. The value of the average residences in UK had lost by about 20% during this period.  The figure below reflects that the prices of residence declined sharply during the period 2008 to 2011 by 25% after this GFC.

The crunch in credit was mainly driven by huge increase in default on the sub-prime mortgages. The crunch in credit also adversely affected in the UK. The mortgage lenders in UK did not lend bad mortgages to the people of this nation. However, this credit crunch had large control in UK than that in US. The Northern Rock bank in the UK was the main victim of this GFC.  However, the crunch in credit resulted in huge problem in this region of UK.  This region had high percentage of financed loans as well as risky loans through reselling it in the capital sector. Due to this crisis, this region faced huge difficulties in raising funds in the capital markets (Luckhurst 2016). As a result, there was huge shortage of funds and hence they asked for help of emergency funds from the Bank of England. Owing to this action, the customers feared about their savings and hence they started to withdraw it from the banks.  In addition, the crunch in credit has led to change in UK mortgage market. However, the mortgages in this nation have become highly expensive. As a result, the risky product of mortgages has been eliminated from the UK market. Furthermore, the banks in UK continued to face huge problems such as HBOS struggled in financing their balance sheet. The Northern Rock bank financed increase in lending with the help of borrowing. As a result, the money markets in UK could not increase money for maintaining liquidity (Atkinson, Luttrell and Rosenblum 2013). It also led to decline in price of houses. As the mortgages were very difficult in achieving, it slumped the housing demand in the nation. This resulted in decline in prices of houses and led to negative equity. Owing to lack of supply, the prices of houses in UK recovered quickly from the international market.

Effects of the Global Financial Crisis on the Employment Rate in the UK

The GFC totally changed the condition of imports as well as exports in UK. Besides UK, several other countries faced huge decline in exports as well as imports of products and services. The exports of goods from UK were not absorbed by other countries and this led decline in this nation’s export by near about 22.1% in USD. Hence, the GFC had adversely affected the trade in UK.

When large banks in UK began to grasp, there was immediate fall in lending between two banks. The financial institutions in UK that still continued in borrowing fund had found that interbank lending rate had  increased overnight (Grant and Wilson 2013). In addition, the insuring credit cost increased at high rate and thus decrease in lending led to downturn in various types of business especially in housing sector. This resulted in huge losses in banks and bankruptcy of companies in this nation.

The 2008 GFC has adversely affected on the exchange rate of UK. However, the currency of UK (sterling) reduced by near about 7700 points and this in turn also triggered to decline in imports by one fifth of total amount during this period. As some people moved the money out of this nation, they purchases other currencies leading to reduction in the Sterling value.

There are several factors that influences the currency value that includes- deficit in current account, reduction in value of exchange rate etc. Therefore, if this nation has huge deficit in current account, then it can be predicted that deficit in trade might give downward pressure on their currency (Demirguc?Kunt, Detragiache and Merrouche 2013). However, the decline in Sterling value in the year 2008 was related to trade deficit in UK and low competitiveness. . Moreover, zero rate of interest, printing of money and rise in debt also puts pressure on the exchange rate value.

During the recession period, inflation rate should likely to decline. This is because lower rate of inflation might facilitate the nation in becoming  more competitive , which in turn might raise the currency demand leading it to increase.

If the nation enters into financial crisis, the investors might lose their confidence. For example, GFC means rise in debt to nations GDP and this in turn might results to concern over the bonds reliability. But the investors might also keep hold of their confidence in their currency despite moving into recession period.

Effects of the Global Financial Crisis on the Housing Market in the UK

The GFC during the year 2007-2008 led to sudden change in UK’s economic policy. Prior to this GFC, the UK government changed the economic policies preaching price stability, financial regulation and fiscal prudence. There are basically three main policies that the capitalist government adopts for controlling the economy, which includes- fiscal policy, monetary policy and supply side policy (ChinaAbout.net, 2017). Fiscal policy refers to the policies in which the instrument applied by government of the respective country affects the economy such as taxation policy, public expenditure etc. On the other hand, monetary policies consists of few instrument such as interest rate, money supply, valuation in exchange rate that government implements for mitigating the effects. Furthermore, supply side policies refers to the tools that encourage expansion of output as well as production in a particular nation with the objective of attaining various economic targets.

The UK government decided to implement various schemes that provides guarantees to the depositors for eliminating bank runs. As the Northern Rock of UK faced huge bank runs, the UK government had guaranteed 100% return on deposits for the depositors. The limit of this guarantee had increased to 50,000 GBP in the year 2008. Moreover, the government also implemented policies on tax cuts such as 120 GBP cut in tax to the basic tax payers in this nation. In addition, land tax and stamp duty was eliminated on the properties that valued at 175,000 GBP. Even, the corporation rate of tax was reduced in the year 2008 from 30% to 28%.  The UK government also strategized to spend 4.5 billion pounds on their public works that includes public housing, energy efficiency. The government increased their spending and the revenue obtained from taxation reduced. Hence most of the expenditure was done with the help of borrowing.

The UK government also pursued expansionary monetary policy that aimed at raising the aggregate demand in order to counter decrease in GDP level (Cukierman 2013). For easing LIBOR and rate of interest in this nation for attempting to limit crunch in credit and making enough funds available. Additionally, the government used supply side policies insufficiently as the influence of it generally takes place for long time.

Conclusion

The GFC has adversely influenced many countries apart from US. Northern Rock, the retail bank of this country had been the first main causality from this GFC. However, they had to take help from the Bank of England for the emergency funding. From then onwards, this nation faced numerous adverse consequences. There was impending crunch in credit owing to lack of liquidity and this had been reflected from the high rates of LIBOR that recorded to 6.5%. Meanwhile, there had been growing concerns about the insolvencies as well as soaring levels of debt amongst the public.  It also increased the level of unemployment of UK and this adversely affected the GDP of the economy. In the fourth quarter of UK in the year 2008, the GDP declined by 1.5%. Additionally, it had huge impact on the prices of residence and exchange rate in UK. Moreover, adoption of economic policies by the UK government including expansionary monetary policy, fiscal and insufficient supply side policies helped the economy in recovering from the GFC.

Effects of the Global Financial Crisis on the Manufacturing Sector in the UK

References

Atkinson, T., Luttrell, D. and Rosenblum, H., 2013. How bad was it? The costs and consequences of the 2007–09 financial crisis. Staff Papers, (Jul).

Berkmen, S.P., Gelos, G., Rennhack, R. and Walsh, J.P., 2012. The global financial crisis: Explaining cross-country differences in the output impact. Journal of International Money and Finance, 31(1), pp.42-59.

ChinaAbout.net. (2017). THE FINANCIAL CRISIS: UNITED KINGDOM – POLICY RESPONSES FROM THE GOVERNMENT - ChinaAbout.net. [online] Available at: https://www.chinaabout.net/financial-crisis-united-kingdom-policy-responses-government/ [Accessed 16 Nov. 2017].

Chor, D. and Manova, K., 2012. Off the cliff and back? Credit conditions and international trade during the global financial crisis. Journal of international economics, 87(1), pp.117-133.

Choudhry, M., Marelli, E. and Signorelli, M., 2012. Youth and total unemployment rate: The impact of policies and institutions. Rivista internazionale di scienze sociali.

Cowling, M., Liu, W. and Ledger, A., 2012. Small business financing in the UK before and during the current financial crisis. International Small Business Journal, 30(7), pp.778-800.

Cukierman, A., 2013. Monetary policy and institutions before, during, and after the global financial crisis. Journal of Financial Stability, 9(3), pp.373-384

Demirguc?Kunt, A., Detragiache, E. and Merrouche, O., 2013. Bank capital: Lessons from the financial crisis. Journal of Money, Credit and Banking, 45(6), pp.1147-1164.

Denis, S. and Kannan, P., 2013. The impact of uncertainty shocks on the UK economy.

Frankel, J. and Saravelos, G., 2012. Can leading indicators assess country vulnerability? Evidence from the 2008–09 global financial crisis. Journal of International Economics, 87(2), pp.216-231.

Grant, W. and Wilson, G.K., 2013. Consequences of the Global Financial Crisis (p. 287). Oxford University Press.

Luckhurst, J., 2016. Strategic Economic Effects of the GFC. In G20 Since the Global Crisis (pp. 23-61). Palgrave Macmillan US.

Rodrik, D., 2017. Populism and the Economics of Globalization (No. w23559). National Bureau of Economic Research.

Sawyer, M., 2012. The tragedy of UK fiscal policy in the aftermath of the financial crisis. Cambridge Journal of Economics, 36(1), pp.205-221.

Scanlon, K. and Elsinga, M., 2014. Policy changes affecting housing and mortgage markets: how governments in the UK and the Netherlands responded to the GFC. Journal of Housing and the Built Environment, 29(2), pp.335-360.

Shiller, R.J., 2012. The subprime solution: how today's global financial crisis happened, and what to do about it. Princeton University Press.

Silas Sargunam, S., Sathish Kumar, A. and Mary, T., 2016. Global Economic Crisis-Causes and Consequences. ITIHAS-The Journal of Indian Management, 6(1).

Statista (2017). UK unemployment rate 2000-2016 | Statistic. [online] Available at: https://www.statista.com/statistics/279898/unemployment-rate-in-the-united-kingdom-uk/ [Accessed 16 Nov. 2017].

Tanveer Choudhry, M., Marelli, E. and Signorelli, M., 2012. Youth unemployment rate and impact of financial crises. International journal of manpower, 33(1), pp.76-95.

Te Velde, D.W., 2012. The global financial crisis and developing countries Taking Stock and Taking Action. Briefing Paper No, 54.