Macroeconomics - Why has the UK recovered so fast?

Just in time for the unit 2 exam, and in good time for unit 4 students, this week's Deloitte Monday Briefing looks at the reasons behind the rapid recovery of growth in the UK. The Monday Briefing always makes very good reading, and often features analysis which is written with great clarity by Ian Stewart, their Chief Economist in the UK - to subscribe and receive an email every week, visit www.deloitte.co.uk/mondaybriefingBelow, I have copied much of this week's briefing with a little additional comment to emphasise the role of monetary and fiscal policies, and to look forward in order to consider how these may be evaluated in order to assess the contribution they may make in the near future.

Deloitte Monday Briefing: What Caused the UK Recovery

Background

* On average, economists expect the UK economy to grow by around 3.0% in 2014, almost twice what was expected a year ago. Why has the UK economy bounced back so rapidly?

1.Monetary Policy

* Probably the biggest factor is that low interest rates, Quantitative Easing and cheap money policies have finally fed through to the economy. There has been a longer-than-usual time lag, due to massive lack of confidence, and to ‘dislocation in the financial system and elevated perceptions of risk’ but it is now working.

* Here is the evidence: Over the last year, credit availability has improved for all sizes of businesses, mortgage lending has risen by 25% and consumer credit has started to recover. Easier credit conditions have helped fuel recoveries in car sales and in the housing market. The fact that the Bank of England policymakers are worrying aloud about the housing market shows that, in some respects, monetary policy may be too loose.

Looking ahead:- might this sudden release of pent-up consumer demand lead to demand-pull inflation?

* For most of the last four years earnings have lagged behind (cost-push) inflation, squeezing consumer spending power. The severity of that squeeze has eased in the last two years as inflation has fallen. Consumers have started to spend and, lower inflation, together with rising consumer borrowing and windfall gains from payment protection compensation, have provided the fuel.

2. Fiscal policy

* Just over a year ago the International Monetary Fund warned that the government's programme of cuts in public spending was "playing with fire" and risked a third recession. The austerity has continued, yet growth has returned.

* This falls short of complete victory for austerity. As Keynesian critics of the Chancellor's policies point out, the economy has been helped by an easing of the fiscal squeeze in the last year. Still, recovery has come even as the government has stuck to a recognisable programme of austerity.

Looking ahead:- cuts in government spending will only really start to kick in this year, and are planned to accelerate over the next few years. Will the effects of this dent growing confidence for both consumers and businesses, and hold back growth, or will the reduction in injections from government spending simply help to cushion fast-growing consumption and investment?

3.External factors

* The end of the acute phase of the euro crisis has also played a part in the recovery. A declining risk of a break-up of the euro area has reduced a major source of uncertainty and bolstered financial markets and business confidence in the UK.

Summary:

* Cheap money, lower inflation, improving prospects in Europe have helped drive Britain's recovery. Austerity has not proved as great a drag on growth as some feared. Recovery is taking root, so much so that policymakers are mulling when and how to intervene to calm things down. Investment and consumer incomes seem close to a turning point, offering the prospect of broader-based growth to come. Markets are worrying less about UK growth. Speculation about the timing and means of monetary tightening are likely to move centre stage.