Assessment

Assessment

The UK economy has proved remarkably resilient during the recent downswing with output falling only a little below potential. At the same time, inflation has remained close to the target and the unemployment rate is among the lowest in the OECD. More recently the economy has been gaining considerable momentum, well ahead of the euro area. This strong performance is underpinned by wide-ranging structural reforms and sound macroeconomic policy frameworks. A pro-active monetary policy successfully stabilised activity and inflation, helped by a strong transmission channel operating through the housing market.

The government budget balance was in substantial surplus at the peak of the cycle and this has enabled fiscal policy to be strongly supportive of growth during the downswing, although the government deficit has now become sizeable. In the context of this impressive macroeconomic performance the decision that was taken in June 2003 to wait further before holding a referendum on entry into the European monetary union is perhaps unsurprising. All in all, the United Kingdom seems well placed to take advantage of the global recovery and move towards a more broadly based growth that relies less on consumption and housing wealth. (Bruijn, 2007, 12-123)

Magnitude of recent output gapsAs a percentage of potential GDP 

1. A positive output gap denotes output below potential output.Source:   OECD.

Developments- 2000-2007

Looking ahead, three major policy challenges arise:

In the short term, it will be important to gradually withdraw the policy stimulus to avoid running into supply constraints at a premature stage of the ongoing upswing. Early monetary tightening will also contribute to reducing the risk of macroeconomic instability that may emerge from the housing market, but there is also an issue as to what other policy measures might contribute to this.

In the medium term, improving the quality of public services in a cost effective way in such priority areas as health and education will be a major challenge. This may be helped by slowing down the ongoing build-up in public expenditure. A smooth phasing in of new spending could also ease the difficult trade-off between raising taxes or departing from the government's “golden rule” and Code for Fiscal Stability.

In the long term, the challenge is to raise growth performance further, by reducing the still sizeable productivity gap with the best performing OECD countries, while inactivity of some groups is still of concern. (Bruijn, 2007, 12-123)

Inflation in essence implies “too much money chasing too few goods”. Inflation is a condition of continuously increase in the price level. It affects individuals, businesses & the government. Inflation has been generally regarded as an important problem to be solved and a primary concern for the policymakers. Two types of changes can be caused by inflation. First, there may be a temporary burst of inflation as the general price level changes from one equilibrium level to another. Secondly, there may be a continuous change in the level of prices. Inflation that is caused by shifts in aggregate demand must be distinguished from inflation that is caused by shifts in aggregate ...