The Economic Crisis of 2008 and the UK Government Response


The current economic crisis which had its roots in the US sub-primes market produced a profound displacement in UK economic policy, Hodson et Al ( 2009 ) . The latter suggests that prior to this crisis UK economic policy centred on three rules which included financial prudence, low rising prices and unequal ordinance and supervising of the UK banking sector. However, the consequence of the crisis was so terrible that the authorities refocused economic policy such that big public sector adoption was necessary. This was due to the fact that a figure of big UK Bankss were in problem holding had exposure to the troubled sub-primes market with subsequent bad debts on their balance sheets, Hodson et Al ( 2009 ) . Therefore, in order improve the wellness of the Bankss the UK authorities became effectual stockholders utilizing revenue enhancement remunerator ‘s money. The Bankss which were assisted include Northern Rock, HBOS and Lloyds TSB every bit good as the Royal Bank of Scotland. However, the rule ground for authorities intercession was to supply liquidness to the interbank loans market and facilitate Bankss to impart to houses and consumers, Hodson et Al ( 2009 ) . It was envisaged that one time sufficient liquidness had been provided to the interbank market, so the Bankss would be willing to impart to each other and so the Bankss would be able to impart to the wider economic system. The entire cost of authorities action to debar a prostration in the fiscal markets amounted to 28 % of GDP, Furceri et Al ( 2009 ) .

The Economic Crisis of 2008

The roots of the fiscal crisis which surfaced in July 2007, and which became worldwide after the collpase of Lehman Brothers on 14th September 2008, Guillen ( 2009 ) , lay in the sub-prime mortgage market in the United States, Lapavitsas ( 2009 ) . It was between 2001 to 2003 that mortgage loaning in the US rose significantly until 2006. At the bosom of the fiscal crisis lay the fact that loans for places were being made to those who would non be able to go on to do refunds on the mortgages either because they lost their occupations or involvement rates increased. The latter may be a consequence of the authorities seeking to stem a short term addition in rising prices.

Therefore, the planetary economic crisis of 2008 had its roots in 2007. In the US, fiscal establishments were imparting money to borrowers whose income was deficient for them to comfortably maintain up the payments on mortgages, Hodson et Al ( 2009 ) . However, as house monetary values were traveling up more and more bad loans for mortgages were being made. It was due to the fact that these mortgages were valuable because the monetary values of houses were increasing that US investing Bankss took the mortgages and securitised them to organize CDO ‘s. Nevertheless, the job started when US house monetary values began to fall, Hodson et Al ( 2009 ) . In this instance, as the monetary value of US houses began to worsen the securitised debt besides began to lose value.

However, by this clip the securitised debt had been cut up into smaller balls and siphoned off to Bankss around the universe, stoping up as liabilities on their balance sheets, Hodson et Al ( 2009 ) . Some Bankss had larger balls of securitised debt on their balance sheets than other Bankss while some Bankss had no exposure to securitised debt at all. In the period 2004-2006, US $ 1.4 trillion worth of mortgages had been securitised.This represented 79.3 % of all sub-prime mortgages, Lapavitsas ( 2009 ) . Furthermore, harmonizing to the latter securitisation was the procedure whereby morgages were parcelled into little sums puting them into other fiscal constructions and selling the tonss as new securities. These new securities or CDOs ‘ were to be held by fiscal establishments around the universe. However, as involvement rates began to lift after 2004, mortgage foreclosures increased.The consequence of the increased foreclosures was that the securities became worthless and Bankss were unable to sell or merchandise them and increase their hard currency assets, Lapavitsas ( 2009 ) . The fact that Bankss had worthless, untradeable liabilities on their balance sheets put into uncertainty the solvency of UK every bit good as other planetary Bankss. These fiscal establishments preferred to roll up liquid assets alternatively of guaranting that liquidness to other Bankss was maintained through the interbank market. The ensuing liquidness deficit was characterised by the motion between the interbank loaning rate and the 3 month Overnight Indexed Swap rate. The Overnight Indexed Swap rate was exceeded by the interbanklending rate after August 2007 with the difference making a extremum in the last one-fourth of 2008, Lapavitsas ( 2009 ) . Therefore, liquidness dried up with Bankss unwilling to impart to each other ; and accordingly to houses and consumers.

It is now clear that the jobs in the US lodging market started when involvement rates rose and house monetary values began to fall. At the same clip the cost of borrowing to houses began to increase, doing it more expensive for them to be able do productive investings which maintained current employment and generated farther employment. In this instance people began to be laid away and unemployment in the UK began to increase, Hodson et Al ( 2009 ) . Furthermore, in the UK people began to lose their occupations demand for goods and services fell and in the US as the figure of lodging foreclosures began to increase significantly as people were laid away. Once people began to acquire laid off they lost their capacity to pay for the mortgages which they had taken out, Hodson et Al ( 2009 ) . As the figure of foreclosures soared and house monetary values to drop even deeper, the values of the securitised debt which was sitting on the balance sheets of Bankss around the universe besides began to fall in value. A effect of this was that the liabilities side of the bank ‘s balance sheet began to increase. As rumors began to distribute in the market that some Bankss were more exposed than others to bad securitised debt, Bankss became fearful of loaning to each other through the interbank market. The impact of this was reduced ingestion, increasing unemployment and overall contraction of the economic systems of developed states, including in the UK.

The UK authorities was therefore confronting an economic crisis which was non alone to this state but portion of a far wider planetary contagious disease whose spread was facilitated by the mechanics and linkages of globalization, Lapavitsas ( 2009 ) . However, the authorities in its response to the crisis had to guarantee that the Bankss did non prostration, continued to impart to each other and to consumers and houses in the wider economic system. The following subdivision will look at the UK authorities policy response in more item.

The UK Government Response

The UK was one of the European states to be hit the hardest by the planetary economic crisis which began with the US sub-primes crisis. The crisis led to the first tally on a UK bank since the latter portion of the nineteenth century with the whole banking sector confronting near meltdown 12 months subsequently with the prostration of Lehman Brothers on the 18th September 2008, Hodson et Al ( 2009 ) . Furthermore, the latter suggest that the ensuing recognition crunch and the bursting of the UK lodging bubble have had a profound impact on the UK economic system which has required a UK authorities policy response which has had to be non merely significant but besides has had to put aside regulations such as those associated with competition policy which would non usually have been done, Hodson et Al ( 2009 ) . It has besides been suggested in the literature that the UK economic system will contract by about 4 % in 2009 with rising prices falling by 1.7 % and unemployment making 3 million before a sustained recovery boots sets in, NIESR ( 2009 ) . Furthermore, the economic crisis has led to unprecedented economic policy co-ordination at an international degree with policy preparation at the national and international degree invariably germinating, Pauly ( 2009 ) .

Hodson et Al ( 2009 ) suggests that the policy paradigm which was followed by the UK Labour Party following its 1997 election triumph was basically the New Keynesian consensus on macroeconomic policy, the complex of policies which changed after the crisis. Specifically, the UK authorities relied on financial policy and pecuniary policy although doubtless, the latter was dominant. With respects to financial policy, the chief drivers included the decrease in the VAT rate from 17.5 % to 15 % ; and an addition in authorities adoption. Indeed the authorities ‘s adoption demands increased 5 crease from its degree in 2007-2008 to its degree in 2008-2009 with the adoption demand traveling from2.3 % of its GDP in 2007-2008 to 11.3 % in 2008-2009. The addition in authorities adoption was non due to the work of automatic stabilizers and was in fact outside the work of the automatic stabilizers which caused the authorities to suspend its normal financial regulations for borrowing. On the other manus with the usage of pecuniary policy the authorities was able to make far more extended surgery to the UK economic system. First, the Bank of England dropped bank base rates from 5.75 % in November 2007 to 0.5 % in April 2009. This process was meant to do borrowing cheaper in the interbank market and ease general bank loaning to the wider economic system leting houses to borrow to put, while the decrease in VAT was meant to cut the costs of houses so that they would non put off staff, Hodson et Al ( 2009 ) . In footings of an IS-LM analysis the increased loaning by the Bankss due to take down bank base rates would be reflected by the LM curve switching downwards with national result theoretically increasing. However, the lowering of bank base rates did non work in the mode dictated by theory, Hodson et Al ( 2009 ) . The latter characterise the impersonal impact of the lowering of bank base rates on interbank loaning by detecting that neither did the volumes of interbank loaning addition or interbank rates fall. Furthermore, because rising prices besides fell, the Bank of England was unable to pull strings the existent involvement rate. For illustration, if rising prices is high and the nominal rate of involvement is low, so it is possible to hold negative degrees of the existent involvement rate, Hodson et Al ( 2009 ) . However, this may non be possible when the degree of rising prices is falling or really low. This is declarative of the fact that possibly the pre-crisis policy of aiming rising prices was set at excessively lower rate and a higher rate of possibly 5 % should hold been operational to give more flexibleness to the Bank of England when utilizing pecuniary policy. The failure of the usage of involvement rates to decide the crisis led to the Bank of England conveying into action new policy instruments such as quantitative moderation and the Asset Purchasing Facility ( APF ) , Hodson et Al ( 2009 ) . The former policy instrument allowed the Bank to impart against securities utilizing its price reduction window in order to increase liquidness. Furthermore, the APF allowed the bank non merely to impart against securities but to buy them from other fiscal establishments.


This paper has evaluated the causes of the planetary economic crisis of 2008 and the subsequent policy response of the UK authorities. It has been shown that the crisis began the US sub-primes market and spread globally due to the securitisation of sub-primes mortgages which therefore entered the circulation of the planetary fiscal system. The subsequent busting of the US lodging bubble made the securitised debt worthless and as a effect loaning in the interbank loaning market dried up with Bankss waiting to neglect with black effects. The authorities ‘s policy response to the crisis was at first to utilize both pecuniary and financial policy with financial policy concentrating on an addition in authorities adoption and a decrease the rate of VAT. Monetary policy at first relied on the usage of take downing bank base rates to excite interbank loaning. However, this did non work because rising prices was at a low and so the authorities resorted to utilizing irregular techniques such as quantitative moderation and the Asset Purchasing Facility to increase liquidness in the market. The authorities still faces the jobs associated with the demand for coordinated action amongst state provinces to cover with the crisis every bit good as the chance that there may be a 2nd recognition crisis which involves non Bankss or houses but consumers and autonomous provinces.


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