Britain: Economic Performance and Impact of Brexit

This report focuses on the economic performance of Britain and the impact of Brexit on its economy. It covers the history of the country, monetary and fiscal policies, and exchange rate movement. Find study material and solved assignments on Desklib.

INTERNATIONAL FINANCE
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Britain
Executive Summary
Britain underwent a series of major turbulence and the Brexit referendum led to the major halt.
The people of the British decided to abandon the European Union. The exit led to the major
issues and impacted the overall economy. The report emphasizes on Britain and its economic
performance. The report initiates with the history of the country followed by the economic
aspects of the country. It then discusses the monetary and fiscal policies. Further, a
differentiation is done with the US dollar to know the performance of the pound.
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Contents
Contents......................................................................................................................................................3
Introduction.................................................................................................................................................3
Background..................................................................................................................................................4
Economic aspect..........................................................................................................................................5
Monetary and Fiscal policy of Britain..........................................................................................................8
Exchange rate movement..........................................................................................................................11
Analysis of the potential factors that affect the exchange rate.................................................................12
Conclusion.................................................................................................................................................16
References.................................................................................................................................................17
Appendix ……………………………………………………………………………………………………………………………………………. 19
Figure 1 Growth Forecast............................................................................................................................4
Figure 2 Estimate of Exit from Brexit...........................................................................................................6
Figure 3 Inflation in Britain..........................................................................................................................7
Figure 4 Monetary policy in the UK.............................................................................................................9
Figure 5 Net borrowing of UK....................................................................................................................10
Figure 6 Pound vs Dollar............................................................................................................................12
Figure 7 Investment ahead of Brexit..........................................................................................................13
Figure 8 Rate of interest............................................................................................................................15
Introduction
The British underwent a turbulent history. It was a period marked with invention, advancement,
and other discoveries of astrology yet it remained laced with supernatural opinions. During the
era, Britain rested on immense exploration and mighty conquests were seen. The economy of
Britain rose by 0.2 percent in the last three months preceding December 2018 that projected ease
from a 0.6 percent expansion in the previous period and getting in touch with the expectation of
the market. Private consumption, as well as government consumption, were the chief catalyst of
growth while gross capital formation and net trade contributed in a negative pattern. The GDP
rate in the UK averaged 0.60 percent from 1955 until 2018 that reached a height of 5 percent in
the initial quarter of 1973. The economists were correct in their prediction concerning inflation.
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The pressure on living standards led to the halt in the year 2018 that surged in the year 2017. The
depreciation happened after the call of the British referendum in 2016 (Collins, 2017). There are
different predictions however the economic horizon spells a different story for the UK in 2019.
This study stresses on Britain and together with the position it held in the economy. Further, the
pound is differentiated with the US dollar to provide an accurate analysis. This study even sheds
light on Brexit that shook entire Britain. The rate movement was negatively impacted when the
Brexit came into force and the same is put to discussion.
Figure 1 Growth Forecast
(Financial Times, 2018)
Background
At the time of Anglo Saxon king, Athelstan who was present in the 10th century has descendants
from where United Kingdom name came into existence. In the later years, it was found that the
kingdoms that were situated far away came under the rule of English dominion. In accordance
with the Acts of Union of 1536 as well as 1542, Wales in Great Britain which is a congeries of
Celtic kingdoms was united with England. Scotland was ruled by London since the year 1603
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and later in the year 1707, it was joined by Wales and England to form the United Kingdom of
Great Britain.
It has been found that the United Kingdom has contributed a lot in term of technology and
industry to the world economy. It was also found that after World War II the major exports of the
United Kingdom included cultural, theatre, literature, film, music and television. The biggest
export that the United Kingdom has made is the English language which is very commonly
spoken in various countries and is considered to be the leading medium of economic exchange.
The pre-literate hunter was the occupants of Britain at that time and they were far away from the
main Europe which later came to be known as the English Channel. The extensive study by the
archaeologist has helped us in gaining information about the people living in that era and about
their lifestyle.
England was obtained as a prize because of the protection provided by the inhabitants and the
rugged climate but it sooner had to face attacks from Rome. Any student who learns Latin and is
a beginner knows well about the campaigns by Julius Caesar in 55 and 54 BC which was
immortalized by his own writings as well as paintings.
Economic aspect
Britain is considered to be the fifth largest economy of the world on the basis of its Nominal
GDP (Gross domestic product) and also has a 3.3% of world GDP. The economy is highly
developed and market-oriented. It is the ninth largest based on the purchasing power parity and
22nd on the basis of GDP per capita.
In the year 2016, the UK was considered to be the sixth largest importer of the world and the
ninth largest exporter. It is considered to be one of the most globalized economies. It comprises
of Scotland, Wales, England, and Northern Ireland. Also, it has the third largest inward as well
as outwards foreign direct investment. A major portion of the GDP approximately 80% is the
contribution of the service sector. The service sector was able to contribute this much because of
the financial services provided by London because it has one of the largest financial centers. The
aerospace industry of Britain is considered to be the second largest in the entire world. Also, the
pharmaceutical industry of Britain is considered to be the tenth largest in the world. It was
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observed that the economy could prosper because of the production of gas and oil. In 2016, the
reserves of the country were estimated to be 2.8 billion barrels whereas in 2005 it was an
importer of oil. There are huge variations in the prosperity of various regions, with North East
Scotland and South East England being the richest area per capita.
Figure 2 Estimate of Exit from Brexit
(Financial Times, 2018)
The economy has an average growth rate of 1.5% per year which is neither very impressive nor
very disastrous. The real wage rate of the workers was seen to be rising. It was observed that the
retail spending fell during the end of the year, and it was also seen through the surveys that the
new orders taken up are not progressing. It is obvious that a lower investment in business affects
our efficiency and productivity which could be hazardous for economic health.
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A negligent behavior towards spending on building and equipment was observed which affected
the employment significantly. It was observed that firms stopped investing in major projects after
the crisis. But they should have grabbed the opportunity because resources were more easily
available at a cheaper price (Blanchard & Leigh, 2013). If we talk about the real income of the
people, the cost of living had risen compared to the time before the crisis happened.
Figure 3 Inflation in Britain
(BBC, 2018)
A weaker pound is bad for the economy but to look upon the positive side it would be an
attractive destination. The residents of the UK will have to pay a higher price to travel abroad.
Keeping this situation in mind, a survey was performed which provided the results that showed
39.2 million visitors came to the UK and spent approximately £24.5bn (Sampson, 2017).
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The exports of the country also rise when the currency of the home country weakens because the
same goods will be available to the international customers at a lower price which would
increase the demand for goods. The export was higher when compared to the past but could not
meet the expectations (Sampson, 2017).
Monetary and Fiscal policy of Britain
The government is trying to implement new policies to fight against the recession and increase
economic growth after the financial crisis that happened in 2007-2008. The following write up
will help to know how the implementation of fiscal and monetary policies has contributed to
achieving the objectives.
The monetary policy is set up by the government to have an effect on the aggregate demand by
making certain changes to the supply and cost of money. It reduces the interest rate which
encourages people to borrow money and invest in the best plans available. The government
wants people to invest money, grow it and enhance wealth for the future.
• The Bank of England frame the monetary policy for the economy. There two main objectives
are to control inflation and also look after economic growth. The two main components required
for the implementation of the money supply is the interest rate and money supply.
• Fiscal policy deals with government expenditure and taxation activities. It majorly influences
the level of borrowing by the government.
The objectives of setting up monetary and fiscal policy are below:
 Lower inflation.
 Generate employment and control unemployment.
 Try to control the deficit in the current account of the BOP.
 To maintain a long term public finance
 Maintain strong economic growth and avoid inflationary growth.
Figure 4 Monetary policy in the UK
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(Financial Times, 2018)
In the UK, the monetary policy is managed by the monetary policy committee of the Bank of
England. The chancellor sets up the interest rate but in the year 1997, the Bank of England was
provided with the authority of setting up interest rates. The role of the government is to set the
target inflation rate only which is 2%.
Figure 5 Net borrowing of UK
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(Financial Times, 2018)
The role of fiscal policy is to moderate the economic cycle of the country. However, it is not
easy to bring modifications in the tax rate in order to control the inflationary pressure. So, the
government decided to give the work of economic management to the Bank of England.
The other tool used in moderating economic cycle is the automatic fiscal stabilizers. During the
recession, the government tends to receive lower tax revenue and spends more on unemployment
benefits.
In certain cases, the government may also plan to follow the expansionary fiscal policy. For
instance, in the year 2009, the government reduced the VAT rate so that it could stimulate
economic activity. This led to an increase in borrowing by 10% of GDP. This increase in the
public borrowing acted as a stimulus for a depressed economy but there was also a presence of
huge political costs. At the time of recession, the government could intentionally increase the
aggregate demand by rising government spending and lowering the taxes. An increase in
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disposable income is a result of lower taxes. It also helps in reducing the unemployment rate and
increasing economic grot.
Exchange rate movement
Dollar vs the Pound
From 2012 to 2018, the British pound has been tagged as $1.35 to $1.75 in U.S dollars. There
has been huge debate as to why the British pound is stronger than the U.S dollar considering the
fact that the United States is stronger and powerful as against Britain. The major explanation that
can be cited in this regard is the nominal value of the currency of the country and the economic
strength has little to do in this scenario (Kettle, 2016). The nominal value of the currency is
arbitrary in nature. It needs to be considered that the currency value changes over time with
respect to other currencies. In 2018, the pound is striking at $1.54 to one pound that is down
from $1.71 to one pound in 2014. This trend is an indication of the condition that deteriorated in
Britain together with an enhanced improvement in the U.S economy. It needs to be noted that
more dollar is in circulation as against pounds. In 2018, 1.7 trillion U.S dollars are in circulation.
In contrast, the total pound comes into circulation to a mere 69 billion.
The vote in Brexit favor shocked the markets and had a strong influence on the British pound
that declined in value over 8% in a span of 24 hours following the vote. This can be cited
another example where the relative value trump over the nominal value (Kettle, 2016). While the
pound is stronger than the dollar in nominal terms, investors abandoned the currency owing to
the decline in the relative value.
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Figure 6 Pound vs Dollar
(Financial Times, 2018)
Analysis of the potential factors that affect the exchange rate
Inflation has been turned to be a very important indicator for the currency markets when
analyzing the monetary policies. It has been generally observed that the countries which are
having higher inflation rates are generally observing depreciation in their currency values for the
long run. Economics is not exactly science but still, the investors watch the balance of trade in
order to analyze the market. If a country suffers from a negative trade balance which shows that
it imports more than it Exports then it is more likely or the value of the currency to fall.
There is certain political uncertainty which can lead the investor to think about the weaknesses of
the economy and then change their decisions which may the currency value to fall. Sometimes,
the value of the currency also helps the exported because we can sell more goods (Cohen, 2016).
However, for a country like Britain which is involved in a lot of trading activities, it is a great
concern to witness a sharp decline in the value of the currency. Also, it can be clearly said that if
devaluation supported the economic success of the country, then the Venezuelan and people of
Zimbabwe what celebrate their richness. (Foster, 2017)
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It was observed at the beginning of June this year that the Brexit negotiations started. With the
passing time, the investors and other people are of the thought that an increase in volatility for
the pound, and other major currency will be observed because of the Brexit negotiations. In the
end, all the major currencies will be dependent on the most powerful political leverage because
of which it is necessary for us to evaluate the geopolitical and economic factors as we play a very
important role in the analysis of exchange rates (Zelenyuk, 2014).
It will be observed that in countries like North Korea, the German chancellor, and the UK a
tensed situation will be created because of the leadership struggles that are being faced by them.
It is unlikely but also possible for a reversal of Brexit vote because of which a positive impact
can be created on the value of the pound.
Figure 7 Investment ahead of Brexit
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Supply, as well as demand results in the foreign exchange rate. The demand for British goods
sees an appreciation when there is an increment in the Pound. The Eurozone economies are
under tremendous pressure because there are more chances of its getting sold that would lead to
depreciation (William, 2016). The most common factors that tend to influence the currency
exchange of the UK are as follows:
Inflation
The rate at which the prices of goods, as well as services increase, is termed as the inflation rate.
If the UK inflation is low then the purchasing power of the Pound Sterling will enhance in
comparison to other currencies (Stone, 2016). In this scenario, UK exports will be more
competitive in nature and there will be more demand to absorb Pound Sterling. This is followed
by a very high-interest rate. Countries that have a lower inflation rate witness an appreciation in
the currency value (Grierson, 2017).
The annual inflation rate in the UK fell to 2.1 percent in December 2018 from 2.3 percent in the
month of November 2018. It was the lowest rate of inflation since January 2017 and this was due
to lower petrol cost and airfares.
Rate of Interest
There is a strong correlation when it comes to inflation, the rate of interest and exchange rate.
When money is deposited in the UK, it becomes attractive if UK rate of interest rises in
comparison to various other countries. When savings is done in UK banks, there can be a better
rate of return that will lead the pound to rise (Grierson, 2017). The central bank has the power to
inflation, as well as currency exchange rate by manipulation of the rate of interest. Since the UK
has a lower inflation rate, it will tend to have a major effect on the appreciation of the pound.
Speculation of currency
Currency speculation happens when the investors opine that the exchange rate is valued in a
wrong manner and hence, the currency is purchased or sold to make profits. If the currency is
pegged at a certain level and the investors believe that the currency is overvalued then a selling
pressure will happen and downward pressure will be applied (Stone, 2016).
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The case of Brexit projected a situation where the sterling declined in a sharp manner. When the
vote of UK withdrawal happened more volatility was seen. Imported goods became more
expensive in the scenario while exports became cheaper in nature. The UK pension got a major
set back because the pound has declined in value and magnitude (Cohen, 2016). On a short term
scenario, it can be commented that the Brexit was a major shock to the overall political and
financial planning that lead to force long position of speculation (William, 2016). The outcome
to exit the EU led to the disturbance in the pound volatility and spread downward. In the long
run, the central bank action to put stability on the sell-off led to the major depreciation through
lowering the rates. The status quo loss created a political dearth with a stake and immense
consequences for the pound, uncertainty in on the power of transition, lack in terms of
transparency, etc.
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Conclusion
From a fundamental perspective, it can be said that the pound has an interesting history however,
it is not different from other currency in contrast to the other prime drivers. The behavior can be
ascertained by the overall buying and selling in terms of the UK’s goods, as well as financial
assets. Before the Brexit, the balance of payment of UK was the weakest in the developed world.
The current deficit is set at 6% of GDP and foreign hold of UK assets at its peak. To ensure the
stability, the UK brings in 6% of the GDP in net capital flows from the overall world. A sharp
reset in needed so that the economic balance can be restored and prosperity can be gained. A
right balance can be attained with the help of strong regulation and tax policies. It is imperative
for Britain to establish bridges that will aid in the acceleration of economic growth and overcome
the issues that were created by the Brexit vote. Hence, in all probability, British foreign policy
will strive to negotiate terms that are favorable in nature with the EU and can take into
consideration more alliances of unorthodox nature like the partnership with the US or NAFTA.
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References
Blanchard, O.J. and Leigh, D. (2013). Growth forecast errors and fiscal multipliers. The
American Economic Review, 103(3), 117-120. Retrieved from:
https://www.imf.org/external/pubs/ft/wp/2013/wp1301.pdf
Cohen,I.K. (2016). Economics for Business – A Guide to Decision Making in a Complex
Global Macroeconomy. (1st ed). London. Kogan Page.
Collins, H. (2017). Brussels releases criteria to host EU agencies after Brexit. Retrieved from
https://www.reuters.com/article/us-britain-eu-agencies/eu-states-set-for-squabble-
over-who-gets-londons-agencies-after-brexit-idUSKBN1AG1S8
Foster, A. (2017). What is Brexit and what is going to happen now that Britain has voted to
LEAVE the EU? Retrieved from https://www.express.co.uk/news/politics/645667/Brexit-
EU-European-Union-Referendum-David-Cameron-Economic-Impact-UK-EU-exit-leave
Financial Times. (2018). Latest on UK economy & Business. Retrieved from
https://www.ft.com/content/691e3c92-051e-11e9-9d01-cd4d49afbbe3
Grierson, J. (2017). Net migration to UK drops to lowest level for three years, Retrieved from
https://www.theguardian.com/world/2017/aug/24/net-migration-to-uk-drops-to-lowest-
level-for-three-years
Kettle, M. (2016) Brexit stage left: how theatre became the best way to understand today’s
Britain. Retrieved from
https://www.theguardian.com/commentisfree/2017/mar/10/brexit-stage-left-theatre-best-
way-understand-britain
Sampson, T. (2017). Brexit: The Economics of International Disintegration. Journal of
Economic Perspectives, 31(4), 163-184. Retrieved from:
http://personal.lse.ac.uk/sampsont/BrexitDisintegration.pdf
Stone, J. (2016) Vote Leave designated as official EU referendum Out campaign. Retrieved
from: https://www.independent.co.uk/news/uk/politics/vote-leave-designated-as-official-
eu-referendum-out-campaign-a6982491.html
William, O. (2016). Brexit: Sociological Responses. (2nd ed). London: Anthem Press.
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Zelenyuk V. (2014). Scale efficiency and homotheticity: equivalence of primal and dual –
measures. Journal of Productivity Analysis, 42(1), 15-24. Retrieved from:
https://ideas.repec.org/a/kap/jproda/v42y2014i1p15-24.html
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Appendix
1. UK Net Borrowing
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2. British Pound performance
3. Rate of Interest
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21