- VAT increase and spending cuts - which have both reduced aggregated demand and reduced confidence in the economy. People now expect a second recession; nor is it just limited to manufacturing but also the service sector.
- Global slowdown, especially in EU.
- After effect of balance sheet recession - reluctance of banks to lend, e.g. quantitative easing led to increase in bank reserves which largely have not been lent to other parts of the economy.
The Chancellor feels vindicated in pursuing spending cuts because of the turmoil in other EU bond markets. By contrast, the UK government is able to borrow at low long term interest rates 2.5%.
- Other European countries have pursued even bigger spending cuts (Ireland, Greece and now the likes of Italy). Interest rates are high in Euro countries because of liquidity fears which are greater when a country doesn't have an independent monetary and exchange rate policy. (see: why UK bond yields have stayed lower than EU)
- The low interest rates in the UK are partly due to the markets expectation of very low economic growth.
- The slowdown in UK economic growth will reduce cyclical tax revenues and keep welfare spending high. As other European countries are learning, you can pursue painful austerity measures, but these just prove self-defeating as the lost output harms the budget situation.
- The government pursued the wrong objective. They saw short term deficit reduction as the highest economic priority.
- Their target should be strong economic recovery and reducing unemployment. Against this back drop of strong economic recovery and growth, the economy could then absorb necessary changes to the long term structural deficit.
The situation had many parallels. - The idea that short term pain (unemployment, low growth) is good for you. But, it is isn't. A double dip recession will make everything worse including reducing long term budget deficit.