The language of economics and the financial system can be confusing to those not immersed in the world of pensions, government bonds and bear markets.
But word got around as the Conservative Party’s mini-budget spooked markets, causing the pound to collapse and the cost of borrowing to rise in the UK. Here is an explanation of some of the phrases and ideas being passed around.
Why is “supply economy” mentioned?
The economic theory is all the rage, having been fully embraced by Britain’s new Prime Minister, Liz Truss, and her Chancellor, Kwasi Kwarteng, at their controversial ‘fiscal event’.
The theory states that the supply of goods and services within the economy is the main driver of growth. Quite frankly, it’s about giving tax cuts to wealthy individuals or large corporations, which in turn creates jobs and later increases the number of taxpayers and boosts the money collected by the Treasury. The prime minister’s approach has been dubbed “trussonomics,” and supporters talk a lot about baking a bigger economic “pie” for all to share.
The theory was particularly popular in right-wing circles in the 1980s. British Prime Minister Margaret Thatcher, along with US President Ronald Reagan, experimented with this type of low taxation economics, the the results of which have since been disputed.
Owen Humphreys via PA Wire/PA Images
The term “trickle-down” economics – the benefits generated at the top that trickle down to everyone – has become synonymous with the idea.
When it comes to supply-side economics, commentators invariably refer to the Laffer curve — a graph showing the relationship between tax rates and the amount of tax revenue governments collect. It is named after Arthur Laffer, a member of Reagan’s economic policy advisory board who also advised Thatcher and earned him the nickname “father” of supply-side economics.
When do we know we’re in a recession?
A technical recession is defined by two consecutive quarters of declining economic output – measured by gross domestic product (GDP), which attempts to summarize all the activities of businesses, governments and individuals in an economy into a single figure.
Some people argue that the term “recession” is an unreliable indicator because people could suffer all the effects of an economic downturn, such as: B. Long-term unemployment, but the data could not officially say so.
Kwarteng has admitted the UK is “technically” in a recession, although official figures have yet to confirm it.
In 2020, the Office for National Statistics (ONS) officially declared Britain into a recession – the steepest on record – after the economy slumped 19.6% between April and June due to the coronavirus lockdown.
This was followed by a 2.2% drop in the previous three months – the first recession since the 2008 global financial crisis, when the UK went into a year-long recession.
What is inflation?
At its core, inflation is the measure of how quickly the cost of goods and services is increasing. It’s an average across many categories, so rising food prices could still be offset by falling gas prices.
In the UK, the ONS is tasked with estimating the rate of inflation.
It has a shopping cart of goods and services that it tracks. It might help to think of this as a giant shopping basket of what the ONS thinks people in the UK are buying. It includes around 730 items, ranging from brokerage fees to condoms, wild bird seed to gasoline, and crumpets to pet food.
What’s in the shopping cart changes every year — with some additions and some removals — because what people are buying changes. Antibacterial surface wipes have been added for 2022, along with meatless sausages and other items.
What role does the Bank of England play?
The Bank of England, owned but independent by the UK government, is tasked with keeping inflation under control and meeting a target of 2% a year.
But in recent months inflation has started to run away. It hit 9.9% in August and is still expected to hit a new 40-year high “just under 11%” despite government measures to freeze energy bills, according to the central bank.
The Bank of England also has a broader mandate to ensure the health of the economy. Many will remember the pro-business stimulus in the form of quantitative easing – often referred to as money printing – deployed during the 2008 financial crisis.
How does interest rate fit in?
An interest rate is a measure of what the cost of borrowing is or the reward of saving.
The Bank of England’s ‘base rate’ – the rate at which banks borrow money from the central bank, which has billions of dollars in assets – affects the rates offered on the high street for mortgages and savings.
Raising and lowering interest rates is the blunt tool at the bank’s disposal to control the economy. An increase in interest rates raises the cost of borrowing, making both borrowing and investing more expensive. The idea is to slow down the economy and curb rising inflation. Lowering interest rates is an attempt to achieve the opposite effect – to boost growth by making borrowing cheaper and in turn encourage investment.
UK Interest. See story ECONOMY Rates. Infographic PA graphics. An editable version of this graphic is available if required. Please contact [email protected]
PA Graphics via PA Graphics/Press Association Images
Ahead of the mini-budget, the bank raised interest rates by 0.5 percentage points – the seventh hike since December – to keep inflation under control. Now some analysts are predicting that the key interest rate will have to rise from the current 2.25% to as high as 6% next year.
What about bonds and yields?
The Bank of England has also intervened to try to rein in rising government bond yields – known as gilts – as they have soared, causing public borrowing costs in the UK to soar.
It said it would buy bonds “to any extent required”. The bank stepped in to calm markets after some types of pension funds were threatened with collapse.
Bonds are loans that investors make to a bond issuer that can be issued by companies or governments to raise money.
A bond’s yield is the amount of money an investor receives for owning the debt and is presented as a percentage of its price. When a bond’s price falls, its yield increases.
Yields fall when investors are less willing to own the debt, meaning they pay a lower price for the bonds.
Alarm bells went off as 10-year UK government bond yields rose above 4%, the highest since the 2008 financial crisis, and more than tripled from 1.3% at the start of the year.
The higher yield reflected investor concerns about the state of the UK economy and, in turn, is affecting how much interest banks charge on different types of loans, particularly mortgages.
Comments are closed.