CDMA Policy Notes

PN105	The UK Economic Cycle and Macroeconomic Policy
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PN106	Finance Causes Growth: Is It True?
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PN105 [Top]

The UK Economic Cycle and Macroeconomic Policy

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The most recent business cycle began in 1997Q2. We base this assertion on our new measure of potential output. We use this new measure of potential output to highlight developments in UK macroeconomic policy. We show that, during the course of 1990s, monetary policy can be characterised by a simple policy response function, featuring the deviation of the inflation rate from the Bank of England’s target and the output gap. We also estimate a fiscal policy rule and find that, between the late 1980s and the mid-1990s, the budget surplus moved closely with the economic cycle. There was, however, a significant structural deficit. In the second half of the 1990s, there appears to be a break in the relationship between fiscal policy and the business cycle. Fiscal tightening between 1997 and 2001 facilitated the removal of the pre-existing structural imbalance. Fiscal policy has been loosened since 2001. Substantial tightening in fiscal policy would be required to remove the newly created structural deficit.

 

PN106[Top]

Finance Causes Growth: Is It True?

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We note that the finance-growth debate is, in some policy circles, beginning to be thought of as a resolved one. There are a number of reasons for not coming to this conclusion. First, the absence of a detailed historical context detracts from our understanding of the finance and growth mechanism. Second, empirical estimations are prone to selection bias. Third, common theoretical mechanisms linking the financial sector to the rate of economic growth typically omit the dynamic and disaggregated elements which appear, in the historical literatures, to be so important. Fourth, the extent of calibration of the theory to data has not, as yet, contributed significantly to the shape of policy analysis. We detail each of these four aspects of the finance-growth nexus and introduce work that seeks to address these omissions.