Contemporary and General Managerial Issues
UK’s Responses towards the Global Credit Crisis

Analyse the mechanisms and briefly evaluate the effectiveness of the macroeconomic policy measures introduced by the UK authorities in response to the global credit crisis and associated UK recession.

 

Introduction

In late 2007, the subprime mortgage crises burst in the United States, and fast to spread to other regions around the world in 2008. Those countries, whereby the banking system and the private or public investment arms in the country, which are exposed to subprime related toxic assets are being affected adversely (Roubini, 2010). Of this, it can be seen that the Europe region is affected in the most serious manner. The United Kingdom is not being spare from the crises. As a result, UK entered the Great Recession era in 2008 (Tucker. 2008). In response to the crises, the government of UK, leaded by the central bank of UK, namely, the Bank of England had implemented several policies and measures to save the country from entering into deeper economic depression. In this paper, the mechanism used by the government to tackle the threats of the Great Recession will be analyzed. From hindsight, the effectiveness of these macroeconomy policies will be investigated. The paper will be concluded by suggesting several implications and lessons learned from this crisis.

Macroeconomic Policies by UK Authorities

As early as in the late summer of 2007, central bank of UK, namely the Bank of England had started to provide some lifeline to British banks, after several insolvent banks begging for bailout (Roubini, 2010). Many of these banks are exposed to toxic assets packaged from irresponsible investment bankers in the United States. As such, Bank of England, leaded by Mervyn King, had no choice but to act as the lender of last resort, to provide necessary liquidity to the marketplace. As the situation became more serious, the central bank of UK had no choice but to insure Northern Rock’s deposit as well as providing more lines of liquidity to the troubled bank (Tucker. 2008). Later, such kind of blanket deposit guarantee was then offered to all other banking institutions in UK, to prevent bank run. In October 2008, the Credit Guarantee Scheme is implemented by the Bank of England in UK (Creel et. al., 2009).

However, despite the good efforts by Bank of England, the crises seemed uncontained. Following on that, on March of 2009, following the highly aggressive monetary expansionary policies practiced by the Federal Reserve in the United States, the Bank of England announced that it will pump a total of GBP 75 billion of new money into the nation’s economy system. Such a measures, never been implemented before, is called quantitative easing (Roubini, 2010). At the particular point of time, the effects of quantitative easing were largely unknown, as that was the first time such aggressive policy was implemented in the human history.

Under the quantitative easing, it can be seen that Bank of England will create new money electronically for itself, to purchase highly depressed toxic assets from the financial markets (Farley, 2010). Such a measure, it of course to pump huge liquidity to enhance market confidence on the economy, as well as to takeover problematic assets from the troubled financial institutions. Besides, as commented by Mervyn King, the Governor of Bank of England, quantitative easing will be necessary to prevent the inflation rate from falling below a targeted rate of 2% per annum.

Effectiveness of the Policies

At the time when the macroeconomy polices are implemented, a lot of critiques can be heard. This is primarily due to the unprecedented scale of the crises as well as the uncertainty if the new measures, particularly quantitative easing, is useful. However, on hindsight, as of the period in early 2011, it can be seen that the policies implemented were roughly effective. With the advantages of hindsight, it can be seen that the UK economy began its slow, albeit weak recovery in the late 2009. Then, the economy outlooks became more promising in the year of 2010. Not only is that, the equity market also recovered strongly, with the market index rising sharply in a period of 1 year (Congdon, 2009). Thus, generally speaking, the policies implemented are roughly effective in handling the crises, as it is reasonable to expect that such aggressive measures are not being implemented, the economy of UK may fall further into the year of 2010.

There are solid reasons on why such measures are useful to tackle the serious credit crises in UK. Firstly, during period of crises, bank run can be a dangerous situation, that could collapse the economy of a nation. Thus, it is crucial for the Central Bank to prevent such a situation from happening. Thus, to provide guarantee on the deposits of the public held in the banks are important. Besides, to buy over toxic assets will enhance people’s confidence on the banks. From another perspective, liquidity can be considered as the lifeblood of capitalism (Roubini, 2010). When the banks fall into trouble, it is essential for the central bank to ensure sufficient liquidity in the economy system, for lending to the business corporations and businesses entities. Thus, to provide liquidity is crucial to prevent fall of businesses in large scale due to liquidity or credit crises. When the businesses fail, large scale unemployment will result, and a vicious cycle of economy deleveraging can happen.

However, it can also be argued that the policies implemented by UK authorities are not sufficient. For example, the unemployment rate in the country remains sluggish. Besides, many of the liquidity pump into the economy (together with the liquidity created in the United States by the Federal Reserve), flow to the emerging countries in the east, essentially creating assets bubble in the region (as can be seen from sky-rocketing house prices in places such as China, Hong Kong, Singapore and other parts of the emerging nations) (Roubini, 2010). Apart from that, in the longer run, the effectiveness of such aggressive measures is uncertain. For example, it is possible that the huge liquidity created will cause commodity boom. Not only is that, the Great Britain Pound had also depreciate in value, due to printing of money by Bank of England to take over toxic assets and quantitative easing. In order to save the economy, government debt had increased tremendously, giving huge pressures to the sovereign debt rating for UK (even though UK is still a relatively strong nation with good credit ratings in 2011, as compared to the PIIGS). Worst, the problems creators, such as those investment banks involved in serious moral hazard, are not punished. It is likely to instill a mindset that they will forever be too big to fail, causing them to engage in unethical behaviors again in the future. The long term side effects, at the time of this writing, are still largely unobserved.

Conclusion

Overall, it can only be concluded that the macroeconomy policies implemented are roughly effective, as from the surface, it can be witnessed that the economy is fast to recover from the credit crises. However, as discussed above, the long term impacts are largely unknown. Most likely, there are more to be done to cater for the potential side effects from the aggressive macroeconomic policies being implemented. Anyway, there are a lot of lessons to be learned from the measures taken by the UK authorities. Firstly, it is important to ensure that the central bank should play the role as the lender of last resorts to prevent the crises from worsening. In times of credit crunch, it is very important to ensure sufficient liquidity exist in the economy to prevent those requiring credit have access to the necessary fund for proper business operations. Secondly, it can be witnessed that the public confidence on the banking system is highly critical. The central bank must prevent bank run at all costs, as bank run will surely collapse the economy, causing people to lost confidence, and ultimately, the economy to enter into a negative spiral loop into recession. Thirdly, it is proven in the crises that in hard times, quantitative easing may be required, as inflationary pressures are preferred from the deflationary pressures (Magnus et. al., 2009) during gloomy economic outlook. Having to say that, the future remains challenging, as the side effects of quantitative easing are largely unknown. Inflationary pressures, particularly on assets and commodity, are showing their ugly heads. Unemployment rate remain high, and there are more to be done to revive the economy to its vibrancy as in the period prior to the credit or financial crises.

 

 

References & Bibliography

Astley, M., Giese, J., Hume, M., & Kubelec, C. (2009). Global imbalances and the financial crisis. Bank of England. Quarterly Bulletin, 49(3), 178-190.

Canarella, G., Fang, W., Miller, S., & Pollard, S. (2010). Is the Great Moderation Ending?-UK and US Evidence. Modern Economy, 1(1), 17-42.

Congdon, T. (2009). QE made in Britain. Financial World, 30.

Creel, J., Monperrus-Veroni, P., & Saraceno, F. (2009). Fiscal policy is back in France and the United Kingdom! Journal of Post Keynesian Economics, 31(4), 645.

Cuockley, F., & Barnes, R. (2008). Subprime Suits. The International Economy, 22(4), 49.

EIU ViewsWire. (2007). UK economy: Economic outlook. EIU ViewsWire.

Farley, E. (2010). Equities, gilts and gold rally in anticipation of QE2. Investment Week,47.

Magnus, G. (2008). The Fed is right to focus on providing liquidity. Financial Times,13.

Roubini, N. (2010). Crisis economics: a crash course in the future of finance. Allen Lane.

Tucker, P. (2008). Money and credit: banking and the macroeconomy. Bank of England. Quarterly Bulletin, 48(1), 96-106.

 

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