British Budget Deficit

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How will the UK government bring the budget deficit down in the next five years? What will be the impact of this on the British economy?

1 Introduction

Of late, the discussion of budget deficit in the UK has been more rigorous than ever. Based on the Public sector finances bulletin by the National Statistics, in financial year 2009/10, the public sector net borrowing was £122.4 billion. As compared to the figures in the same period in 2008/09, this is a staggering £54.6 billion higher. At the end of January 2010, the public sector net debt has amounted to £848.5 billion, which is equal to 59.9% of GDP of UK.

One may question the source of this deficit and debt. Over the past few years, the UK had a booming economic outlook. In the early 2000s until before the recession strikes in 2008, the unemployment rate in the UK was generally low, as shown below.

Data Source: National Statistics

The GDP growth of UK also stayed fairly stable from 1999 until the recession in 2008.

Data Source: International Monetary Fund

The situation of the economy painted an optimistic picture to the government. The recent recession, considered the most serious ‘bust’ ever since the Second World War, also deepened the budget deficit and added to the debt.

When plagued by a recession, it is normal for governments to suffer from a budget deficit. There will be a reduction in employment, which leads to a reduction in tax revenue. Claims for unemployment benefits will soar as well. This inevitably leads to a budget deficit. However, a large and growing deficit is not to be ignored. A research that takes cross-country data has proven that deficits cause a rise in interest rates (Ardagna et al., 2004). This will then lead to a reduct...

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