Tuesday, May 29, 2007

How a US recession Might effect the UK

There are concerns the US economy may be heading towards recession. If the US economy did go into a recession how would it effect the UK economy?

There is an old saying that "If America sneezes, the rest of the world catches a cold"

Discuss the effects on the UK economy of a Recession in the US.

A recession in the US will lead to a fall in UK exports to the US. If UK exports to the US are luxury goods there will be a bigger % fall in UK exports. A fall in Exports could cause a fall in AD. Therefore, it could contribute to a recession in the UK.

Furthermore, a recession in the US is likely to adversely effect consumer confidence in countries, such as the UK.

However, Exports to the US are a small component of AD. Only 16% of our trade is with the US, our biggest trading partner is the EU. Also, it depend upon other components of AD; for example, if UK domestic spending was rising rapidly (e.g. due to rising house prices) then UK AD will probably keep rising.

The UK is likely to have an appreciation in the exchange rate against the dollar, this is because interest rates in US are likely to be lower. Therefore, there will be more hot money flows into the UK. A stronger £ will make UK exports less competitive and therefore reduce AD further.

The effect of a stronger £ and fall in exports to US is likely to worsen the current account deficit. Exports increase relative to imports.

It depends on the strength of the UK economy. For example, at the moment the UK Central bank is concerned over inflationary pressures. A slowdown in exports could help reduce inflationary pressures without the necessity of rising interest rates.

Overall, the effect is likely to be fairly small. However, it depends why the US economy went into recession. If it was due to global phenomena it could effect UK as well.


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