In the wake of the global financial crisis of 2008, and the UK’s biggest recession since the Second World War, UK’s budget deficit, the gap between total revenue and total spending, spiked to around £20 million, or 10% of UK’s GDP. (ONS, 2018) In response to this, the coalition government unveiled a fiscal austerity programme worth £110 billion in 2010, including deep cuts in spending, and an increase in taxes to combat the deficit. This was part of an ambitious 5-year plan to wipe out the deficit entirely. The programme comprised of some policies including welfare spending cuts, cancelling of school construction programme, and an increase in VAT to 20%. However, many argue that austerity measures taken by the UK caused depression to be deeper and recovery to be significantly slower. As a result, causing a rise in unemployment and cost of living; cut in social security; fall in incomes and economic stagnation within the UK.
Some may argue that austerity was necessary to accelerate the recovery as budget deficits were high after the financial crisis which triggered an increase in Britain’s debt to GDP ratio from 35.4% in 2008 to 64.6% within 2 years’ time. (Office for Budget Responsibility, 2018) This may have caused the economy to be unstable as public borrowing became the key source of an increase in GDP but not consumption and investment, which are more sustainable sources in the long term. Additionally, if the budget deficit is unable to be reduced, this can further lead to higher bond yields causing the cost of financing the deficit to increase. Cutting the deficit through austerity measures will indicate that the economy is performing better in the long run, hence providing a higher confidence level to investors. This, in turn, encourages investment in the private sector, which is much needed in order to boost the economy during the recession. In addition, austerity would be necessary since high government spending causes crowding out of the private sector companies. This is because the public sector tends to be less efficient as it does not have the profit motive that private sectors have, resulting in hampered growth which is unbeneficial during a recession.
On the other hand, austerity policy may result in further stagnant recovery and deeper depression. For instance, following the financial crisis and the implementation of austerity measures, the rates of unemployment were persistently high of above 7%, with a 47.8% increase in unemployment mid-2009. At worse, these rates rose up to 7.9% in 2012, which were seen last in 1996. (Eurostat, 2018) Furthermore, the growth of youth and long-term unemployment have increased as well, which may result in long run problems for the UK economy. Since VAT is a regressive tax, the implementation of an increase from 17.5% to 20%, increases the cost of living, especially to the poor as they suffer a larger burden due to their marginal propensity to consume being higher than those with higher income levels. The UK budget of 2010 mentioned the 2-year pay freeze applying to all workers in the public sector earning £21,000 or more, in hopes of reducing £3.3 billion a year. (Hoban, 2010) However, this may not be a very sensible timing as VAT increasing may result in the standards of living to be reduced even further. Therefore, pay freeze may be beneficial in the short run in stopping the deficit from getting worse, but it does not necessarily improve it.
In a recession, the Bank of England usually cuts interest rates in order to stimulate growth. However, interest rates were at 0.5% in 2009, (Bank of England, 2017) which was as low as it could possibly go. This meant it was impossible for them to perform its role effectively of resuscitating the economy. Therefore, the UK economy interacted through monetary policy mainly by injecting up to £375 billions of quantitative easing during the period after the financial crisis between 2009 to 2012. (Joyce, 2013) In March 2009, the Bank of England purchases £75 billion pounds worth of gilts and corporate debt initially over the course of 3 months in order to boost liquidity and reduce interest rates. Then a further £200 billion was injected throughout the subsequent months to promote liquidity even more. Even though there was a partial recovery in the beginning from -0.6% increase of GDP growth to 0.7% at the end of 2009, growth flatlined and the economy recovered slowly due to the UK being affected by the Europe debt crisis in 2011-2012. In response, the BoE implemented quantitative easing again in 2011 of a further £125 billion purchases in assets and an addition of £50 billion in July 2012 to combat the effect the crisis had on the UK.
Alongside with monetary policy, the UK government also introduced a fiscal policy stimulus package worth around £20 billion, or 4% of GDP, immediately after the financial crisis in 2008. This included a temporary VAT cut of 2.5 percentage point from 17.5% to 15% aiming to encourage consumers to increase their spending and in turn boosting the economy. (Giles & Parker, 2009) However, this tax cut only lasted for 13 months, ending on the last day of December 2009, which proved to only temporarily ease the problem. Furthermore, the package also showcased an increase of £2.5 billion on capital expenditure; a welfare scheme of a £60 sum to every pensioner, an increase in child benefit prior to schedule and the delay of vehicle excise duties to rise as intended. The government’s aim of the package was to avoid the economy from shrinking in further depth. However, this did not prove to be successful as the stimulus caused the budget deficit to increase significantly to £12 million in 2009 from £2 million in 2008 (Office for National Statistics, 2018), resulting in an even larger debt to GDP ratio. Following the change from a Labour chancellor to a Conservative one in the mid-2010s, this also meant that the fiscal stimulus was replaced by contractional fiscal policies in order to combat the budget deficit created by the fiscal stimulus package.
In conclusion, the UK’s austerity programme proves to be ineffective in reducing the budget deficit and debt to GDP ratio. Many may argue that austerity measures should not have been taken place whilst a recession was experienced. The result of deep cuts in public spending and tax increases through austerity have demonstrated a rise in hardship especially to people with lower incomes, yet a significantly lower burden was placed on the those on high incomes. Consequently, increasing the country’s inequality and poverty gap. In addition, the monetary policy of quantitative easing executed by the Bank of England had some effect on the UK economy, but only in the short run. On the other hand, there was little evidence the fiscal stimulus package introduced in the period after the financial crisis helped the recovery to a great extent as it only created a larger budget deficit and an increase in national debt.