High budget deficit and public debt could be attributed to the 2007 global financial crisis which perhaps occurred because of the collapse of American sub-prime real estate bubble. Calumniating in the bankruptcy of Lehman Brothers panic was induced in international financial markets, the real global economy and a global deflationary crisis were generated. Additionally, in 2002-2007 the UK saw its bank balance sheet triple. Thus, making it amongst the most leveraged financial systems, vulnerable to the financial crisis and oncoming deep recession. In response, the previous Labor government provided banks £141 billion to avert a collapse and adopted a £31 billion Keynesian fiscal and monetary stimulus project. Fiscal stimulus accelerated capital spending on public services, deferred increasing corporation tax, and reduce VAT. However, these measures possibly increased public debt levels with growth within the economy becoming growth unbalanced. This is because over the last decade economic growth was built upon increased government and consumer dependency on debt-financed expenditure from the financial sector. Contrastingly argue that a large quantity of the debt servicing was because of bailing out financial institutions as opposed to the stimulus measures.
Once the coalition government came into power the policy response was to reintroduce the neoclassical orthodoxy exemplified by the 1920s Treasury View. This suggests private sector expenditure is crowded out by increased government deficits and public debt which damages the economy. Therefore, government intervention should be limited within the free-markets to achieve economic efficiency. Consequently, economic policies abruptly changed from running significant budget deficits to reducing it. Thus, vastly contrasting to the previous governments’ Keynesian policy adoption. Keynesian policies suggest governments Keynesian policy to intervene as the free-market may not necessarily assure full utilization of resources. Additionally, austerity measure further weakens aggregate demand within the economy and make recessionary period worse.
An argument used by the coalition for austerity include it was necessary for growth and vast level of debt were unsustainable, would impact generations, and may increase long-term interest rates. Subsequently, increasing loan repayment which would be unproductive because the opportunity cost would have been spending on public services. Fiscal austerity consisted of £32billion spending reductions, £11billion welfare savings, a two-year freeze of public sector pay over £21,000, and increasing VAT to 20%. Thus, aiming to reduce debt as a percentage of GDP and bringing borrowing under control.
However, these measures initially had contractionary effects with GDP reportedly being reduced by 1.4% during 2011-2012 and growth was weakened. Thus, illustrating a decline in real household incomes. Public debt levels also increased from 56.6% of GDP in 2009 to 90% of GDP in 2013. This is because increased borrowing was required to meet the deficit. Lastly, austerity measures further contributed to increasing inequality.
Before the financial crisis, the UK was amongst the most unequal countries in the OECD. Illustrating this Gini coefficient increased from 26 to 40 in 1979-2009. However, after austerity was implemented there were significant social costs. This is because prior mechanisms used to decrease inequality had arguably been dismantled. Increasing regressive taxation and decreasing progressive taxation, labor market deregulation, and reduced public service spending perhaps increased inequality.
Increasing VAT increased income inequality those on lower incomes were disproportionately affected. This is because large proportions of their income are often spent on VAT in comparison to those on higher incomes. Those earning higher incomes are possibly less impacted by a large proportion of their income may be invested into financial assets which further increases their income. Additionally, corporation tax was significantly reduced and income tax was reduced from 50% to 45% for those earning £150,000. Consequently, furthering income inequality. Lastly, by persistently neglecting income inequality the UK is now experiencing wealth inequality as richest 1% of the population owns more than the poorest 20 %.