UK Economy - Case Study
Introduction
A country’s economic environment is affected by several factors, including macro and microeconomic factors. All countries endure regular ups and downs with regard to the growth of jobs, output, spending, and income, and the UK economy is no exception. The business cycle encompasses four key stages: expansion phase, when there is a rise in demand for consumer and capital goods; recession phase when we have a decline in production and sales; and depression phase which is characterised by a further reduction in demand for services and products, triggering massive shutdowns of some of the production facilities, and recovery phase which manifests in a renewed rise in consider confidence regarding the market (Suter and Herkenrath, 2012). During the recovery period, the bank gives out loans and low lending rates thereby making it possible for businesses to finance their projects. The increased aggregate demand in the economy also leads to a rise in productivity. Also, companies begin to employ due to the rise in their production capacities, thus causing a rise in consumer income meaning they are now in a position to afford to buy capital goods. Firms begin to record an increase in profit margins, and there is also an increase in the gross domestic product (GDP). The following report is based on the United Kingdom (UK) imports as well as the country’s attempt to recover from the 2007/08 global financial crisis. Using models and concepts, the report endeavours to explore the impact of the decline in the British pound on UK imports, as well as the impact of rising taxation and cuts in government spending on the UK trade deficit.
Recovery
Recovery entails the upward swing in the real GDP of a country from its lowest point on the trough, following a recession. This has been exemplified by Figure 1 below:
Figure 1: The four phases of the business cycle
In this case, business confidence is crucial in economic recovery. For example, in the event that businesses anticipate a weak or temporary business confidence, this could subdue possible recovery. Also, a recovery could come about owing to a conscious endeavour to stimulate demand. For example, in the UK, following the 2007 global financial crisis, the government instituted cuts in interest rates, resulting in a 0.2% reduction in the policy interest rate in Mid-2008 (Whittaker, 2012). The government also increased its borrowing rate in a bid to sustain the economy, not to mention the decision by the Bank of England to embrace quantitative easing (QE) in a bid to ensure more money circulated in the country's banking system. This was a deliberate attempt to increase the supply of loans. Another recovery strategy employed by the UK government in order to stimulate demand following the 2008 economic crisis was a temporary reduction in VAT from 17.5% to 15% (Barrell and Weale, 2009).
How the value of imports into the UK is likely to be affected by a fall in the value of the British pound
When the British pound experiences a reduction in its value, there is a resultant increase in the price of imports coming into the UK. This is because the strength of the British pound relative to other major international currencies means that imports into the country are less competitive in comparison with the products manufactured in the UK. Consequently, there is a likelihood of the UK experiencing a reduction in the quantity of its imports (Sepp and Frear, 2011). It is important however to remember that the effect on the value of imports is determined by the ensuing change in quantity demanded. The value of exports and imports of a country depends on the quantity and price of such exports and imports. As such, when a country experiences a loss in the value of its domestic currency relative to the foreign currency, it means importers have to pay more to import goods into the country.
How the value of imports into the UK is likely to be affected by a reduction in the UK productivity
When the UK labour productivity reduces, there is a resultant increase in the unit costs of production of firms in the UK. This is due to the fact that a positive correlation exists between, on the one hand, the labour productivity of a country and on the other hand, the volume of imports of such a country. Therefore, when a country experiences an increase in its labour productivity, there is a reluctant rise in the value of imports in such a country. An increase in the unit cost of production implies that firms could increase their prices, thereby, increasing the competitiveness of imports in the domestic market, thus increasing the quantities of imports purchased (Bowen and Mayhew, 2008). Accordingly, the country increases the amount of money it spends on imports. In the same way, when a country's labour productivity reduces, there is also a reduction in the value of imports.
Possible benefits to the UK economy of a weak British pound
A weak pound could result in three likely benefits to the UK economy. First, it is likely to stimulate an increase in the country's GDP. For British exporters, a weaker pound is good news as it means that their goods will be cheaper in the overseas market, and this might aid in lifting flagging demand (Barker, 2012). The consequent rise in the value of exports will in turn trigger a reduction in the value of imports as it will be expensive to import goods into the UK. This causes a rise in the size of the UK's net exports or the difference between a country's exports and imports, and hence a rise in the UK's GDP. This is best exemplified using the formula: Y = C + I + G + (X-1). In this case, Y symbolises the GDP; C symbolises consumption; G is the government spending, while X-1 refers to net exports.
Second, a weak British pound would increase the cost of imports into the UK. This is because the local currency would have a higher value relative to the international currencies. Consequently, imports would be expensive, thereby compelling UK citizens to opt for domestically produced products that are more affordable. As such, there is a resultant rise in demand for domestic products, and this in turn acts to stimulate the country's economic growth.
Third, a loss in value on the British pound could translate into cheaper exports from the UK, thus enhancing the country's net exports. Firms that export UK goods abroad benefit from a weak pound because foreign buyers require less currency to purchase a similar quantity of goods from the UK. As such, a weak pound implies that UK exporters could increase their profit margins and/or sell their goods at a cheaper price. Nonetheless, this is reliant on the demand of the Pound elsewhere across the globe. In addition, British exports have remained somewhat inelastic in recent years and this could affect the benefits of a weak Pound.
Figure 2: UK current account deficit
