This document outlines the key topics that will be covered in a lecture on recent macroeconomic trends in the British economy. It discusses the causes and consequences of the global financial crisis that began in 2007, including the housing bubble, subprime lending crisis, and contagion effects. It then examines the UK policy response to the recession, including quantitative easing, fiscal stimulus measures, and bank bailouts. Finally, it considers debates around failures of macroeconomic models to predict the crisis and the path to economic recovery.

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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8. Slide 30.8
Griffiths and Wall, Applied Economics 12th Edition © Pearson Education Limited 2012
ABS other, 2.2%
Student
loans, 4.4%
RMBS
(Residential
mortgage backed
securities) , 23.2%
Other, 3.3%Financial
debt, 42.6%
Credit cards, 5%
CMBS
(Commercial
mortgage backed
securities), 6.1%
CDO, 11.4%
Auto
loans, 1.1%
Sector composition

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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22. Slide 30.22
Griffiths and Wall, Applied Economics 12th Edition © Pearson Education Limited 2012
Country
National
Debt 2009
National
Debt 2014
Budget
deficit 2009
Budget
surplus
required* in
2014
US 88.8 121.0 -12.3 4.3
Japan 217.4 239.2 -9.0 9.8
Germany 79.8 91.4 -2.3 2.8
France 77.4 95.5 -5.3 3.1
Britain 68.6 99.7 -10.0 3.4
G20 100.6 119.7 -8.6 4.5
*To bring respective national debts back to a maximum of 60% of GDP by 2014
Source: IMF, World Economic Outlook (various)

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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