1. EC-111 British Economy
Recent UK
Macroeconomic Trends
Dr Catherine Robinson
F35, Richard Price Building
Office Hours: Monday 10:30 to 11:30 and Thursday 9:30 to 10:30
Appointments: c.robinson@swansea.ac.uk

2. Balance of Payments
 During the 1950s and 1960s there were continual
problems with BofP deficits...
 Governments therefore
 Manipulated aggregate demand (stop-go policies)
 Adopted exchange control measures to keep the external
account in balance (devaluation a last resort in 1967 -14%)
 Other policies such as investment incentives to promote
capital formation and long run economic growth
 REPRESENTS A NARROW INTERPRETATION OF
KEYNESIAN THINKING (MAYNARD, 1989)
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3. DID IT WORK?
 The post war period was characterised by a shift to
Keynesian type policies
 Full employment was the target policy objective
 On the whole, it was considered to be a good period of
macroeconomic stability and growth
 Unemployment was held at 2% or below for most of the
1950s and 1960s
 Growth was generally steady and although low, this was
thought to be due to sociological characteristics of the UK
rather than policy failure
 Balance of payments were troublesome, but manageable
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4. Opportunity wasted?
 Conditions post war were conducive a stable macro
economy
 Rebuilding war-torn Europe
 Fixed exchange rates
 Inflation tied to global rate, determined by US macro
policy
 Terms of trade favourable for industrialised countires
 And so had little to do with Keynes..
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5. Change in circumstances
 Things started to go wrong at the start of the 1970s
 The collapse of the IMF monetary system (Bretton Woods)
 Worldwide burst of inflation
 Terms of trade worsened
 Global oil crises
 4 fold increase in oil price between 1973-1974
 A freely floating exchange rate had implications for policy
 Fiscal expansion would force up interest rates and therefore exchnange
rate, reducing private sector demand.
 A wage-price spiral was set in motion
 the breakdown of the Philips Curve
 Stagflation – high unemployment AND high inflation
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6. Inflation (MM23 CPI annual
%change)
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6
0
1
2
3
4
5
6
7
8
9
10
1945 1946 1947 1948 1949 1950 1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969

7. Inflation in the 1970s
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7
0
5
10
15
20
25
30
1970 1971 1972 1973 1974 1975 1976 1977 1978 1979
Note the
change in
scale

8. Inflation (MM23 CPI annual %change)
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8
-5
0
5
10
15
20

9. So, what to do?
 Money was the answer…
 A number of academic think-tanks were looking at the
problem
 National Institute of Economic and Social Research
 The Cambridge Economic Policy Group
 Did not follow the mainstream Keynesian school of thought
 Believed that the market was inherently stable and constant
fine-tuning approach was inappropriate
 Thought that a poor Balance of Payments position was not
helped but actively hindered by fiscal policy
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10. Cambridge Economic Policy Group
 Simple message based on national income accounting:
 If I+G+X=S+T+M
 Then X-M=S-I+T-G
 That is
 balance of payments =f(private sector surplus (savings-
investment) + public sector surplus (taxes net of government
expenditure)
 Private sector surplus is so small, that it can be virtually
ignored
 Therefore – its all down to government expenditure and
tax receipts
 Such that: X-M≈T-G
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11. What does this mean?
 The policy implication of such a model is that any
stimulation policy in fiscal terms must be accompanied
by import controls, otherwise, a balance of payments
deficit will ensue.
 Apply a “Fiscal Rule” within the context of a medium
term strategy for stability
 Stick to the rule and only alter the “par” tax rate for
major disturbances in the global economy
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12. A paradigm shift?
 Things had changed and the „old‟ model was no longer fit for
purpose
 In the 1950s and 1960s
 Rebuilding after the war
 Exchange rates were pegged to the dollar, giving stability
 UK inflation was tied to global inflation which was largely
determined by US macro policy – at the time, very conservative
 The Korean War had just finished which led to a decline in
global commodity prices
 This was partly due to the new floating exchange rate
system....
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13. (1) Floating exchange rates
 In effect, it reversed the role of monetary and fiscal policy
 The government now needed to intervene in currency
markets...fiscal policy without monetary policy would be
ineffective because interest rates and exchange rates
would change
 “It was perhaps as much the transition to floating exchange
rates as the blandishments of Milton Friedman that caused
governments to become monetarists”, Maynard, 1989, p.11
 A decline in „money illusion‟ (real versus nominal prices)
 Inflation changed real relationships...the relationship
between real consumption and real income changed in
Europe
 Consumption function shift
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14. (1) Floating exchange rates
 The UK Government probably didn‟t appreciate all this
at the time
 A reluctance to use interest rates as a policy tool
 A commitment to full employment
 There was in part a belief that the Balance of Payments
had „held Britain back‟ in the 1960s, but when free of
the international monetary system, the economic
growth was not unleashed
 SUPPLY SIDE PROBLEMS??
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15. (2) Relative prices were distorted
 Yes there had been the oil shock
 BUT the UK had its own problems
 For YEARS we had been experiencing a downward trend in
the return on capital employed (ROCE – a measure of
profitability)
 Fell by >75% 1960s to 1970s
 Partly due to oil
 Not down to competitiveness – Unit labour costs improved by
15% 1965-1975...
 The ratio of capital to labour was increasing faster than the
rate of productivity
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16. Why?
 Labour was becoming a less attractive input
 In part because of years of capital subsidies, designed to
stimulate growth (“Going for Growth” Policy) and create full
employment
 In part a function of the incomes policies and the
anticipatory wage demands
 and comparatively strong trade unions
 It didn‟t really manifest itself through decline in employment
because of the absorption of employment by the public
sector
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17. UK Productivity growth
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Table 1.3 Productivity of labour and capital in the UK (compound annual growth rates)
1960s 1969-79 1979-82
Labour productivity 5.8 2.2 3.5
Capital productivity 1.1 -2.6 -4.4
Total Factor Productivity 4.9 1.1 1.6
Source: Maynard, from OECD Economic Outlook, May 1986.
Q=f(L, K, M)

18. In summary...
 The post-war period, though stable, is regarded by
many as a missed opportunity
 Things changed as a result of the oil crisis and the
move to floating exchange rates
 The UK was also affected by the relative prices of
inputs
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19. Next week...
 Friedman and the growth of monetarism
 The rise of Thatcherism
 The start of the „Great Moderation‟
 The productivity miracle
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20. References
Griffiths and Wall (2009) Applied Economics 9th
Edition, chapter 24 .
Maynard, G. (1989) The Economy under
Thatcher, Blackwell, London Chapter 1.
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