Why two thirds of the crisis was not our fault

By Valentina Magri

It was mid-September when the two major economic events that have irreparably changed our lives occurred: the Northern Rock bank run in the UK (13th September 2007) and Chapter 11 for Lehman Brothers in the US (15th September 2008).

In the Eurozone today Italy and France are sick and Germany does not feel very well. The UK is out of recession and the economy is in better shape than its European counterparts, even if some labour market issues have not been solved yet.

A recent paper by the Bank of England has investigated the origins of the crisis and has revealed that it was not (completely) our fault. Let me explain why.

Joys and sorrows of globalisation

As an open economy, Britain is exposed to the economic developments of the rest of the world. A recent paper by the Bank’s International Economic Analysis Division gauged this impact: the correlation coefficient between annual UK and GDP growth is pretty high (0.6 per cent). But why does it happen?

The British economy can be affected by what happens in the rest of the world in two ways: spillovers, namely cross-border linkages, and common shocks, which are economic events that affect all the world.

This situation implies that globalisation has both a bright and a dark side. On the one hand, integration to the global economy benefited Great Britain prior to the crisis. On the other hand, international influences triggered a decline in English growth in 2008-2009 and 2011-2012.

How the Great Recession was “exported” in the UK

An ‘unholy trinity’ made up of trade, finance and uncertainty has allowed the global crisis to be ‘imported’ into Britain.


A shock in demand causes lowering prices and quantities of exported goods. At the same time, English import prices increased, putting pressure on firms’ costs and families’ incomes. Around two per cent of the fall in GDP level by end-2013 was due to trade shocks.


The lack of trust between the banks after the collapse of Lehman Brothers and bank losses due to non-performing loans caused a credit crunch that damaged companies and households. Moreover, many British banks suffered from lost funding because foreign banks short of liquidity withdrew funding supplied to UK banks as a result of short of liquidity.

At the same time, asset prices (especially commodity prices) became more volatile. Subsequent supply shocks led to further increases in these prices, despite the global recovery moderated from mid-2011. Consequent price pressures contributed to UK inflation exceeding MPC’s target (two per cent) after 2010 and to real income squeezing that diminishes the UK demand in 2010-2012.


Macroeconomic uncertainty has to do with what firms and families expect their future incomes to be. A high level of uncertainty means that households postpone spending, firms delay investments and investors demand greater compensation against future risks, increasing borrowing costs. The similar patterns of uncertainty measures in the US, UK and Euro area suggest a correlation between them. It is worth noticing that each single factor interacts with the others; in particular, uncertainty can amplify the other two channels.

The impact of the world and internal shocks on UK activity

The Bank of England’s forecasting models suggests that one fifth of the Great Recession was transmitted to Britain via the trade channel and the rest with the others mechanisms.

The most notable shocks in the British economy were world supply/price shocks and world financial shocks. Overall, world shocks account for around two-thirds of the weakness of the British output since 2007.

What about the rest of the weakness?

One third of the Great Recession was due to British shocks. First of all, British productivity growth has been very weak since 2007 with respect both to the past and to the other countries. This trend may be influenced by weak credit supply in the UK. Furthermore, low productivity has a negative influence on the English supply capacity. Another shock was fiscal consolidation via higher VAT and reduced government spending.

Unfortunately, this news will not help us in avoid another crisis. As a matter of fact, economies are made of business cycles: upturns and downturns. But as the Bank of England concludes, these findings demonstrate “the importance of understanding the international environment for policy makers”. Such a valuable policy lesson, not only for the future of Britain.

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