The future of the UK economy is uncertain

Over the past 15 years, the UK economy has been hit by three major external shocks – the financial crisis, the Covid-19 and now the Russia-Ukraine war – and an internally generated Brexit. We are amazed that its effects are unknown, even unknown.

It has taken a long time, for example, to identify the financial crisis trend as a sharp turning point in productivity growth. However, the Resolution Foundation, in its assessment of the spring statement by Chancellor of the Exchequer Rishi Sunak, noted that “labor productivity increased by only 0.4 per cent year-on-year compared to 2007-19, one of the slowest among rich countries, and much slower than the previous 2 per cent rate of 12 years ago.” “

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This, in turn, explains the stagnation near the real disposable income of the family that preceded this year’s expected exceptional pressure. But why this happened is not yet known. Again, it was predicted that Brexit would make the economy less open to trade. It is unknown at this time what he will do after leaving the post.

Similarly, we know that today’s push has followed the heel of a large and mostly unexpected rise in post-Covid inflation. We know that this is especially true of low-income people. But the full economic impact of the war is unclear.

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The future of the UK economy is uncertain

The Office for Budget Responsibility, however, made a heroic assumption. It helps us to clarify some painful possibilities. The OBR predicts that this new push will bring inflation closer to 9 percent this year, the highest rate in 40 years. Similar rise in inflation is happening in other high-income countries. This increase is driven primarily by higher gas and fuel prices, as well as rising global commodity prices. The OBRO hopes that additional demand in the domestic economy will ensure that these increased costs go to consumer prices. But it assumes that they will only partially coincide with higher nominal wage increases: in short, real wages will decrease significantly.

Importantly, the rise of this inflation is expected to be temporary. The OBR predicts that inflation will decline sharply next year, as current high prices have become the basis for future calculations. This result depends, however, on the belief that nominal wages will lag behind inflation. However, it is expected that the labor market will remain strong and unemployment will remain low. Moreover, the bank rate is forecast to go below 2 percent, which indicates extremely negative real rates everywhere. In short, we will see a combination of a strong labor market and real wage cuts with an expansionary monetary policy.

UK Unemployment Rate Line Chart, OBR Forecast (%) and Unemployment Rate

The economy could easily become much weaker than OBR imagined. Monetary policy may be more stringent; For example, if inflation does not fall. Alternatively, pressure on real income without the need for higher interest rates can result in significantly reduced demand and output. Both options would mean a much weaker economy. A ban on gas exports from Russia would make that result even more promising. The economy will then be in recession.

What is the role of policy and policy makers in all this? The task of the Bank of England remains to be seen: to bring inflation back on track and thus stabilize expectations. It must do so. The Chancellor’s job is much more complicated. That’s right he wants to save his room for revenue strategy. But, according to the Resolution Foundation, policy changes have so far met only one-third of the income push that will hit the poorer half of the population in 2022-23. Given what is happening now and the pressure on real income ahead, he must reduce the short-term impact on poor families more effectively than ever before.

Bank of England Bank Rate Line Chart, OBR Forecast (%) Increased Interest Rate Forecast, but Still Top Rate Low Rate

Even bigger points can be seen. In difficult times, a country needs trustworthy people in charge. The question of the Prime Minister is obvious. At the beginning of the epidemic, Sunak and the Treasury responded impressively. Recently, however, significantly in his Spring Statement, he claimed that he was deducting taxes while raising them (partially freezing the tax threshold in nominal terms). He has replaced bad tax (national insurance) for better (income tax). “Something financially misleading has been proven,” Sunak told Paul Johnson of the Institute for Fiscal Studies.

In fact, he has and is not just a “something”. People will notice the amount of illusion of their pay packets and actual disposable income. He is burning his credibility. It will be bad for him and bad for the country.

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