Chapter 4. The United Kingdom: Imbalances and the Financial Sector

Hamid Faruqee, and Krishna Srinivasan
Published Date:
August 2013
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Shaun K. Roache1

The United Kingdom’s key imbalances over the past decade originate in low saving. Growth has been reliant on private and public consumption financed by high domestic and external borrowing. Public finances entered the crisis with little policy space and are now left in a much weakened state. Household saving fell to unsustainably low levels alongside an overheated housing market. Against a backdrop of low interest rates globally, financial sector excesses contributed to a buildup of imbalances and stability risks. Since the financial crisis, repair of both public sector and household balance sheets has been under way, notably through increased saving. Budgetary consolidation efforts will need to be sustained over the medium term and the performance of the new fiscal framework closely monitored. The rebound in household saving needs to be maintained. Securing strong and sustained growth will therefore require a rebalancing of demand toward net exports and investment and away from consumption. Ongoing financial reform is also crucial to safeguard stabilitya key priority given the United Kingdom’s role as a global financial center.

Leading up to the financial crisis, the United Kingdom enjoyed a sustained period of solid growth, driven largely by consumption (Figure 4.1). GDP growth averaged about 2¾ percent per year between 2000 and 2007, close to the average for the previous two decades. Private consumption growth was higher but also close to its long-run average, at about 3 percent, and it remained the most important contributor to overall growth. Investment remained a modest contributor to growth and net exports were a persistent drag. The most notable difference between the 2000–07 period and the previous period was the pick-up in public consumption growth to around 2½ percent, as fiscal deficits reemerged following a period of net public saving at the end of the 1990s and early 2000s.

Figure 4.1United Kingdom: Contributions to Real GDP Growth


Source: IMF staff calculations.

Strong domestic demand, partly from robust private consumption and partly from fiscal expansion, led to sustained growth but a deteriorating current account balance. The current account deficit increased in the early 2000s and averaged about 2¼ percent during 2000–07. It subsequently fell during the recession, and is projected to improve by 1 percentage point of GDP through 2015. The deficit was financed by large capital inflows into U.K.-issued debt, including (as in the United States) securitized residential mortgage instruments.

Similar to the United States, a sharp and sustained decline in national saving explains a rising current account deficit (Figure 4.2). National gross saving was lower by about 1 percent of GDP between 2000 and 2007 compared with the previous decade. Gross investment was largely unchanged, but quite low, over the same period. High external (and domestic) borrowing came against a backdrop of low global interest rates and steady foreign demand for U.K. assets to finance high private and public spending relative to income and revenue. Some of the more specific trends included the following:

  • Household saving gradually declined on a trend basis for almost two decades before rising sharply during the recession (Figure 4.3). The gross household saving rate (measured as a percent of disposable income) averaged over 9 percent during the 1990s and declined to near zero by 2008 before rebounding by 5 percentage points during 2009–10.

  • Corporate saving increased modestly during the precrisis period (Figure 4.3). Rising gross operating surpluses, particularly in the financial sector, and lower dividend growth both contributed to rising saving (OECD, 2007). Dividend payouts grew more slowly than profits due in part to higher precautionary saving related to expected contributions to corporate pension funds as a result of new accounting standards for defined benefit schemes introduced in 2001 (Bunn and Trivedi, 2005).

  • Public saving fell toward zero during the early 2000s and has turned significantly negative as a result of the crisis. During the late 1990s and through 2001, unexpected revenue buoyancy, faster-than-expected growth, and tight expenditure constraints inherited from the previous government helped public saving rise to over 3 percent of GDP. From 2002–07, saving was slightly negative on average as (discretionary) consumption expenditures—particularly nonentitlement National Health Service spending—picked up. Since 2008, public saving has averaged nearly –5 percent of GDP.

Figure 4.2U.K. Saving and Investment

(Percent of GDP)

Sources: Haver Analytics; and U.K. Office for National Statistics.

Figure 4.3U.K. Gross Saving by Sector

(Percent of income-based GDP)

Sources: Haver Analytics; and U.K. Office for National Statistics.

Investment and productivity are both relatively low in the United Kingdom. The step-increase in corporate saving in the early 2000s did not lead to higher investment (as it might if firms were, say, credit-constrained). Investment has remained at around 17 percent of GDP, toward the bottom end of the range of G20 countries (Figure 4.4). There has also been a persistent gap in productivity levels between the United Kingdom and its major competitors that was only partially closed during the modest pick-up in productivity growth during the precrisis period. Recent analysis indicates that this is due to lower total factor productivity and, particularly relative to France and Germany, lower capital-to-labor ratios that result from weak investment (U.K. Department for Business Innovation and Skills, 2010).

Figure 4.4G20 Saving and Investment

(Average, percent of GDP)

Source: IMF staff calculations.

The financial sector played a contributing role in U.K. imbalances, evident in the link between rising household borrowing and consumption. Rising house-hold borrowing helped sustain consumption’s strong contribution to growth (Figure 4.5). While the household share of national income fell (by about 5 percentage points between 2000 and 2008, in part reflecting a declining wage share), households reduced their saving and borrowed more to sustain consumption growth (Figure 4.6). Lending available for consumption—related to housing equity withdrawals and new unsecured debt—increased from an average of 2½ percent of household disposable income in the 1990s to about 9 percent between 2002 and 2007. This debt can be used to acquire financial assets, enhance home values, or for consumption. Some portion of this new debt was used to acquire financial assets (or upgrade homes), but as the net acquisition of assets of households remained largely unchanged while consumption rose over the period (as a percent of income), a significant part of this borrowing is likely to have been used for consumer spending.

Figure 4.5U.K. Household Consumption and Debt

(Percent of disposable income)

Sources: Haver Analytics; and U.K. Office for National Statistics.

1Housing equity withdrawal plus unsecured lending.

Figure 4.6U.K. Household Income Share

(Percent of gross national income)

Sources: Haver Analytics; and U.K. Office for National Statistics.

Against the backdrop of low interest rates, household balance sheets correspondingly took on more debt—and became more leveraged—in the run-up to the crisis. Household debt increased by 34 percentage points of GDP between 2000 and 2008. At the same time, net wealth was rising, in large part due to higher house prices, but was still outpaced by debt accumulation. The result was an increase in household leverage—defined as the ratio of total debt to net worth—by 9 percentage points to 23 percent at its peak in 2008 (Figure 4.7). Linked to falling household saving rates and increased borrowing, inflated tax revenues accompanied the run-up in property prices. U.K. house prices experienced a large and sustained increase (rising by an annualized 8 to 9 percent between 1993 and 2007), well ahead of modest growth in household incomes (Figure 4.8). At the time the market peaked, the ratio of house prices to average household disposable income had risen to historically high levels. Looking back, rising property prices against modest growth in incomes, increased borrowing and indebtedness, and low household saving reinforced one another in the run-up to the crisis. Rising asset prices also boosted public sector accounts.

Figure 4.7U.K. Household Net Wealth and Debt

(Percent of GDP)

Sources: Haver Analytics; and U.K. Office for National Statistics.

Figure 4.8U.K. House Price-to-Income Ratio

Sources: Halifax; Haver Analytics; and U.K. Office for National Statistics.

Note: Standardized average house price and average household gross disposable income.

Following the boom, some of these self-reinforcing dynamics in the private sector worked in reverse. Since 2008, households have begun to repair their balance sheets by increasing saving to rebuild net wealth damaged by house price declines. Moreover, households have begun reducing debt relative to wealth (i.e., deleveraging), albeit gradually. Notwithstanding recent declines in house prices, housing valuation ratios still remain about 30 percent above their historical averages (IMF, 2012).

Public finances entered the crisis with underlying structural weaknesses and less policy space, before public debt surged when the crisis hit. Public debt increased by about 7 percentage points in the five years leading into the crisis and rose by 32 percentage points of GDP over 2007–10 (Figure 4.9). A number of factors explain the sharp rise in public debt since the onset of the crisis:

  • Much of the deterioration in the fiscal position is structural, reflecting permanent revenue losses (including those related to asset prices and the financial sector) and a sharp drop in potential GDP during the crisis that, in part, reflects the adverse shock to the financial sector.

  • Discretionary stimulus has contributed relatively little, in part because the stimulus has been unwound relatively early and rapidly.

  • The direct net costs of public sector interventions in the financial sector are so far small, although the government continues to face large contingent liabilities.

Figure 4.9U.K. Public Sector Balance and Debt

(Percent of GDP)

Sources: Haver Analytics; U.K. Office for National Statistics; and IMF staff calculations.

Higher public saving and less consumption growth over the medium term imply that growth should rely more on investment and exports.2 Medium-term fiscal consolidation is already under way. Specifically, with public finances on an unsustainable path, the government embarked on an ambitious adjustment plan in 2010 to balance the structural current budget from the 2009/10 deficit of 5½ percent of GDP by the end of a rolling five-year window. Deeper budget-neutral reallocations could further boost public saving and investment and help support growth during the adjustment process.

Similarly, private consumption growth is likely to be restrained as cuts in government transfers slow household income growth and as the need to repair balance sheets keeps the household saving rate high. Tighter fiscal policies and subdued private consumption growth provide the room for monetary policy to remain accommodative for some time (consistent with meeting the inflation target).

The outlook for private investment is brighter, reflecting the likelihood of interest rates remaining low, very high corporate cash surpluses, and relatively faster expected growth in the export sector, notwithstanding weakness in euro-area trading partners, which is more capital-intensive. Sterling has depreciated significantly in real effective terms, though net export volumes have yet to pick up significantly. Net exports are already contributing more to growth during this cycle and this should continue. Over the medium term, net exports should benefit from a more depreciated real exchange rate, as the relative demand for nontradables remains low in light of the ongoing fiscal consolidation and private sector deleveraging.

Repair and reform in the financial sector will strongly influence the rebalancing process and growth. Most importantly, the supply of credit is likely to be tighter in the postcrisis period and likely to restrain demand growth and price increases for housing. Accordingly, to rebuild net wealth damaged by lower house prices, households will need to maintain higher saving. The financial sector will also likely contribute less to overall GDP growth than it did over 2000–07 and, given its current relatively high share of the economy—at about 10 percent of GDP—this will depress potential growth and tax revenues for some time.3

Fiscal adjustment plans give strong reasons to expect a narrowing of the current account deficit. Fiscal consolidations are associated with current account adjustments because they compress domestic demand directly and allow looser monetary policy, which helps keep the exchange rate competitive. With overall fiscal adjustment of nearly 7 percent of potential GDP planned between 2010 and 2015, the current account deficit is expected to decline by 1 percentage point of GDP through 2015.

Root Causes of Imbalances

Low Private Saving

At the heart of imbalances in the U.K. economy was unusually low and declining saving by households, particularly between 2000 and 2008, against a backdrop of relaxed financial conditions prior to the crisis. A number of factors help explain the striking fall in household saving and, separately, the rise in debt. Recent analysis by IMF staff finds a clear link to real interest rates and house prices (IMF, 2011b). Relaxed lending conditions and increased credit availability in the financial sector further encouraged higher borrowing to support consumption relative to subdued growth in incomes. Similar forces were at work in the United States. Some of these developments reflect the natural response of the economy to expanding conditions, but others—notably the high procyclicality of credit supply and overshooting house prices—are due to weaknesses in the financial sector policy framework and market distortions. Specifically, the following factors contributed to low private saving:

  • Low real interest rates. Short- and long-term interest rates declined over two decades through 2007 against a backdrop of lower global interest rates. This reduced the real return on saving and redistributed income from savers to borrowers. If borrowers have a higher marginal propensity to consume (as is likely), this would contribute to lower aggregate household saving. Low interest rates also allowed and encouraged households to support larger balance sheets (e.g., indebtedness), against expectations of further asset price increases.

  • Credit conditions. The supply of credit improved significantly early in the 2000s, which allowed credit-constrained households to borrow more (and save less). The spread of household mortgage rates over the Bank of England’s policy rate declined from over 100 basis points to less than 50 basis points in the decade through 2007 (Bank of England, 2009). At the housing market peak, there was evidence that credit conditions had become excessively lax, but in retrospect financial sector supervisors and policymakers failed to respond appropriately (see below).4

  • Rising asset prices, notably housing. Sharply higher house prices—partly due to supply constraints in the U.K. housing market—boosted net wealth. For households targeting a specific level of wealth (e.g., to fund retirement) this reduced incentives to save.5 House price gains also increased collateral values, thereby increasing the amount of secured borrowing that property-owning households could obtain (notably, through mortgage equity withdrawals) and reinforcing borrowing demand. Expectations of further asset price increases may also have contributed to increased borrowing and indebtedness. Higher prices may have had distributional effects and encouraged higher saving by younger households, but this was partly offset in the United Kingdom by increased credit availability.

  • Constraints on housing supply. These constraints are likely to have contributed to high and rising prices. The United Kingdom is subject to restrictive planning laws that severely restrain the designation of new building areas. This has lowered the price elasticity of housing supply, which is now very low and has declined in recent decades (Barker, 2003). As a result, the boom in house prices was not accompanied by a construction boom (unlike in the United States, where residential investment also rose sharply prior to the crisis).

High Public Debt

The crisis and recession exposed structural weaknesses in the United Kingdom’s fiscal policy framework. In particular, established fiscal rules were not sufficiently strong. The government actually met its own fiscal rules for the 10 years following their adoption in 1998.6 However in retrospect, these rules and policies did not adequately adjust for the economic cycle. IMF staff estimate that the United Kingdom was running a sizable structural deficit at the same time as the economy’s output gap was either closed or positive between 2000 and 2007.7 The bulk of the deterioration in public finances before the crisis was structural and primarily reflected increases in spending on public services. The rules also failed to build in a sufficient safety margin for uncertainty, which may have been underestimated.

Projections for public finances were also consistently overoptimistic and not subject to formal independent review. The fiscal policy framework in place before the crisis was often criticized because it provided insufficient monitoring, transparency, and accountability. Institutional reforms recently adopted by the government should address these weaknesses. In particular, the government has passed legislation to put the independent Office of Budget Responsibility (OBR) on a permanent footing. The OBR has already established itself as an authoritative voice in the fiscal policy debate, particularly with regard to November 2011 forecasts that led to a change in the government’s fiscal tack, notably a slowing of the pace of fiscal consolidation.

Economic growth, estimates of potential growth, and tax revenues became over-reliant on the financial sector and related business services that were taking on more risk. Thin fiscal buffers became more important over time as the U.K. economy and tax revenues grew increasingly reliant on the financial sector for growth. Between 2000 and 2007, the financial and business services sector (including real estate) accounted for just over half of overall GDP growth. To some extent, higher growth contributions reflected greater risk-taking by the financial sector rather than an underlying increase in productivity.8 In turn, the financial sector is estimated to have contributed about 14 percent of government’s total tax receipts in 2007. This tax stream is relatively volatile, as shown by the 21 percent decline in the total collected by the financial sector between the fiscal years 2006/07 and 2009/10 (Figure 4.10).9

Figure 4.10U.K. Stamp Duty Receipts

(Percent of central government cash receipts)

Sources: Haver Analytics; and HM Revenues and Customs.

Finally, revenue was over-reliant on inflated asset prices and windfall gains were not saved. The United Kingdom taxes both capital gains (although not on an individual’s main residence) and equity and property market transactions (through stamp duty). Stamp duty on property is progressively graduated based on its value and this amplifies the sensitivity of the duty’s receipts to prices. Reports by staff of the Organization for Economic Cooperation and Development have estimated that “excess” revenue related to asset prices at cyclical peaks can lead to the overestimation of structural budget balances of the order of 1½ to 3 percentage points in some countries, including the United Kingdom (Girouard and Price, 2004; Price and Dang, 2011). In turn, revenue windfalls, such as those from stamp duty receipts, were not saved, leaving a shortfall relative to spending when they disappeared as asset markets declined.

Financial Sector: Lending Practices, Leverage, and Funding

The financial sector contributed significantly to private and public sector imbalances. Banks and other financial institutions aggressively expanded credit, contributing to inflated output growth, asset values, and tax revenues, and eventually creating large public sector contingent liabilities. Households’ heightened access to expanding credit, in turn, lowered saving and increased debt. This boom-bust pattern reflected market failures and distortions, as well as shortcomings in policies. Banks were increasingly reliant on short-term funding, including from foreign counterparties, to finance the credit boom. Alongside weaker credit standards, this allowed banks to expand credit much more aggressively than would have been the case if constrained by deposit growth.

Shortcomings with “light touch” regulation and supervision facilitated financial sector excesses. The focus by the Financial Services Authority (FSA) on outcomes rather than business practices and enforcement of rules obscured how risks were rapidly changing as new financial markets and instruments developed. Supervision of liquidity risks was inadequate, as financial firms became increasingly reliant on term funding markets. Cross-border supervision was also insufficient, including the inherent risks in foreign exposures of U.K. banks, particularly to U.S. subprime mortgages. Insufficient monitoring contributed to a buildup of financial sector vulnerabilities that, in turn, contributed to macro imbalances.

Are U.K. Imbalances a Problem?

Large deficits and high public debt reduce policy space and threaten to crowd out private investment—and thus impede rebalancing. The very high fiscal deficits of recent years, if left unaddressed, would have caused debt to balloon to over 100 percent of GDP by 2016 and continue on a steeply rising path to even higher levels. Notwithstanding the likelihood that interest rates will remain low for some time, as activity returns to potential over the medium term interest costs on public debt are likely to rise. This would reduce available fiscal space, although the impact of higher rates on debt servicing would be limited by the relatively long maturity of outstanding U.K. debt. Higher interest rates would also adversely affect investment, which must contribute more to growth in a rebalancing scenario. Higher (distortionary) taxes associated with high public debt may also weigh on growth.

A return to low household saving and high leverage, given large public debt burdens, may give rise again to widening imbalances or financial stability risks. U.K. imbalances are all linked to some degree, and reducing fiscal, financial, and external imbalances and their vulnerabilities will serve to reinforce balanced and sustained growth. If left unchecked, key financial risks—were they again to materialize—could severely disrupt growth.

The United Kingdom plays a central role in global finance and, thus, avoiding large financial imbalances and ensuring stability there is essential for strong, sustainable, and balanced global growth. U.K. external assets and liabilities account for a quarter of world GDP, far greater than the country’s share in global trade and output. Global spillovers are therefore limited largely to the financial sector, while trade and other real economy links are modest (IMF, 2011c). Thus, U.K. financial sector stability is a global public good, requiring the highest-quality regulation and supervision. Gradually repairing U.K. fiscal and financial sector balance sheets, and limiting distortions that encouraged previous excesses, should benefit global financial stability and growth.10

How to Address Imbalances

Rebalancing in the United Kingdom requires an increase in public saving and greater reliance of demand on investment and net exports. This will require action on several fronts. In the main, fiscal adjustment—supported by monetary accommodation—is needed. This will need to be complemented, however, by stronger policy frameworks and key structural reforms, including in the financial sector, as described below.

Domestic Priorities

A sustainable increase in public saving should be secured by additional structural reforms that address longer-term fiscal imbalances. Higher public saving would increase national saving and lower the external deficit. The pace of fiscal adjustment will, however, need to take account of the dampening effect on growth in the short run. A stronger improvement in net exports would allow for stronger consolidation, which will need to be sustained over the medium term. In particular, further accelerating increases in the state pension age and indexing it to longevity would reduce the fiscal burden of an aging society. Reform of public service pensions (along the lines of the Independent Public Service Pensions Commission) would help improve their structure and better align average public service compensation with private sector equivalents. The new fiscal framework that is anchored by medium-term targets, and enhanced independent oversight would complement these efforts, but its performance should be closely monitored.11

Monetary policy should remain accommodative for some time—so long as underlying inflation remains in check. With public finances being consolidated, accommodative monetary policy will help keep real interest rates low and sterling competitive, thereby promoting expansion of investment and net exports. The Bank of England has embarked on a fresh round of monetary and credit easing. In addition to expanding its Quantitative Easing Program in July 2012, bringing the total stock of purchased assets to £375 billion (24 percent of GDP), it also announced a “Funding for Lending” scheme in June 2012 to lower borrowing costs by providing banks with multiyear funding. Banks that expand lending faster will receive cheaper funding. However, it is too early to assess the effectiveness of these measures, and additional unconventional measures, such as purchases of private sector bonds, may be necessary if growth continues to stagnate. This said, attendant risks associated with an accommodative policy stance will need to be watched closely.

Housing policy reforms should aim at increasing affordability in order to mitigate excessive house price volatility (affecting household saving and debt). Policies to increase supply should focus on lowering barriers to land access for housing and providing sufficient incentives for local communities to allow development. One aspect of the current system of housing taxation (the council tax) is regressive, encouraging excess demand for housing. It should be modified to better reflect the value of ownership. This would reduce distortions that have contributed in the past to excessive swings in household saving and debt. Reforms would also contribute to improved competitiveness by increasing household (and labor market) mobility and by reducing the cost of living, helping to contain labor costs.

Financial Sector Policies12

Ongoing financial sector reform will help support growth and prevent another buildup of imbalances and stability risks. Policies should focus on strengthening bank balance sheets by building capital rather than reducing assets, in order to balance stability and growth considerations. Liquidity buffers have been increased, but the level of capital across the financial sector is not yet at levels that ensure resilience in the face of prospective risks. Enhanced supervision and oversight are needed to prevent imprudent credit lending and excessive leverage that contributed to low saving. It is also essential to address “too-big-to-fail” issues, including by legislating reforms proposed by the Vickers Commission, as described below.

The macroprudential toolkit should be enhanced and actively used. Monetary policy working alone through interest rates may not be sufficient to safeguard both price and financial stability. The newly formed Financial Policy Committee (FPC) should focus on tools that are most effective against the credit cycle—including loan-to-value ratios—and minimize efficiency costs and scope for regulatory arbitrage.

To safeguard stability, continued buildup of capital and liquidity buffers is essential for resilience to shocks. Specifically, the FPC and the FSA should continue to encourage banks to raise external capital as early as is feasible, while linking the approval of dividends and variable remuneration to the outcome of stress tests. In this context, the FPC should also clarify its expectations about the transition path to Basel III capital ratios, as an accelerated pace could exacerbate deleveraging and have adverse cyclical implications.

Since the introduction of the new liquidity regime in 2010, liquidity requirements in the United Kingdom have been more stringent than in other jurisdictions. This has proved effective in strengthening banks’ liquidity and funding positions, but may have constrained credit availability, particularly as market stress related to the euro area crisis intensified. Going forward, the FPC should evaluate liquidity requirements with a view to converging into the phase-in schedule agreed upon internationally, while taking into account cyclical considerations and the availability of liquidity insurance from the Bank of England. At the same time, banks should be encouraged to continue to improve their funding profiles by expanding their deposit bases and lengthening the term of their wholesale funding. Given U.K. banks’ vulnerabilities to funding shocks, the Bank of England should stand ready to provide liquidity through a range of facilities if strains from the euro area crisis intensify. In this regard, banks’ prepositioning of collateral facilitates potential access to these liquidity operations.

The United Kingdom is moving toward a permanent legal basis for a new supervisory framework, one important objective of which should be to promote prudent lending. A Financial Services Bill to provide a permanent legal basis for the new framework is currently before Parliament, and is expected to come into force in early 2013. It will create a new Prudential Regulation Authority (PRA)—a subsidiary of the Bank of England—responsible for prudential regulation of banks, large insurance companies, and large investment firms. The FPC will be in charge of macroprudential policy. The result should be greater integration of microprudential and macroprudential supervision to better safeguard financial stability. A separate agency, the Financial Conduct Authority, will be responsible for the conduct and regulation of secondary markets, investment funds, investment firms, and small insurance companies, as well as consumer protection issues across all institutions. Successful navigation of the transition, combined with the new model of intensified supervision, will require skillful management and a serious commitment of resources. To avoid a return to weaker lending standards and mispricing of credit risks that contributed to excessive borrowing and low household saving, the new supervisory framework should:

  • Strengthen the FSA’s assessment of bank processes, including loan classification, determination of impairment, and valuation practices.13

  • Introduce a proactive intervention framework. It is important that framework legislation include explicit support for early intervention by the supervisor in dealing with prudential problems.

  • Provide the regulatory authority with oversight powers at the holding company level. This will improve consolidated supervision.

  • Enhance data reporting standards. The United Kingdom lags behind many other countries in standards for the public disclosure of bank and insurance sector data. Regular and comparable data on an institutional basis should be published, including nonconfidential data from prudential returns.

Progress in addressing too-important-to-fail issues needs to be further advanced to restrain excessive risk-taking. Specifically, incentives for excessive leverage could be reduced through further tax reform. Ring-fencing of retail operations and the establishment of depositor preference would improve resolvability of the retail entity.14 However, ring-fencing should be weighed against the costs as it does not necessarily improve resolvability of the whole entity, unless complemented by more comprehensive measures that require international coordination.

Toward Global Action

The United Kingdom’s contribution to collective action and global rebalancing would rely mainly on longer-term fiscal consolidation. This should not, however, detract from near-term considerations, where policy flexibility will remain important given heightened global uncertainty. In particular, further longer-term reforms to entitlement programs such as the state pension and public service pensions should be implemented beyond 2016. Other measures could include additional reforms to reduce the relatively high share of the working-age population that receives disability benefits. As well as contributing to the fiscal consolidation effort, this would also boost the supply of labor (OECD, 2011).

These measures should have positive domestic growth effects and contribute to global rebalancing over the medium term.


    Bank of England2009Quarterly Bulletin 2009 Q3 Vol. 49 No. 3 (London: Bank of England).

    BarkerKate2003Review of Housing Supply Analysis: Securing our Future Housing NeedsInterim Report (London: HM Treasury).

    BunnPhilip and KamakshyaTrivedi2005Corporate Expenditures and Pension Contributions: Evidence from U.K. Company AccountsBank of England Working Paper No. 275 (London: Bank of England).

    Financial Services Authority (FSA)2009Mortgage Market ReviewFSA Discussion Paper 09/3 (London: Financial Services Authority).

    GirouardN. and R.Price2004Asset Price Cycles, ‘One-Off’ Factors and Structural Budget BalancesOECD Economics Department Working Paper No. 391 (Paris: Organization for Economic Cooperation and Development).

    HaldaneAndrew2010The Contribution of the Financial Sector Miracle or Mirage?Speech at the Future of Finance ConferenceLondonJuly 14.

    International Monetary Fund (IMF)2011aUnited Kingdom: 2011 Article IV Consultation—Staff ReportIMF Country Report No.11/220 (Washington: International Monetary Fund).

    International Monetary Fund (IMF)2011bWhat Drives the U.K.’s Household Saving Rate” in United Kingdom: Selected Issues Paper IMF Country Report No. 11/221 (Washington: International Monetary Fund).

    International Monetary Fund (IMF)2011cUnited Kingdom: Spillover Report for the 2011 Article IV ConsultationIMF Country Report No. 11/225 (Washington: International Monetary Fund).

    International Monetary Fund (IMF)2011dUnited Kingdom: Financial Sector Stability AssessmentIMF Country Report No. 11/222 (Washington: International Monetary Fund).

    International Monetary Fund (IMF)2012United Kingdom: 2012 Article IV ConsultationIMF Country Report No. 12/190 (Washington: International Monetary Fund).

    Organization for Economic Cooperation and Development (OECD)2007OECD Economic Outlook No. 82December (Paris: Organization for Economic Cooperation and Development).

    Organization for Economic Cooperation and Development (OECD)2011Economic Policy Reforms 2011: Going for Growth (Paris: Organization for Economic Cooperation and Development).

    PriceR. and T.Dang2011Adjusting Fiscal Balances for Asset Price CyclesOECD Economics Department Working Paper No. 868 (Paris: Organization for Economic Cooperation and Development).

    PricewaterhouseCoopers LLP2008Total Tax Contribution of UK Financial ServicesReport prepared for the City of London Corporation (December). (London: PricewaterhouseCoopers LLP).

    TurnerAdair2009The Mortgage Market: Issues for Debatespeech atthe Financial Services Authority Mortgage ConferenceMay 12London.

    U.K. Department for Business Innovation and Skills2010Economic GrowthBIS Economic Paper No. 9November (London: U.K. Department for Business Innovation and Skills).

Shaun K. Roache is a Senior Economist in the IMF Western Hemisphere Department. This chapter was written with guidance from Hamid Faruqee and the support of Eric Bang, David Reichsfeld, and Anne Lalramnghakhleli Moses.

The prospects outlined here draw on the 2011 U.K. Article IV Staff Report (IMF, 2011a).

See Economic Contribution of U.K. Financial Services 2010,

For example, the Financial Services Authority estimates that of total mortgage approvals, 45 percent were not income verified; 35 percent were interest only; and 15 percent were at a loan-to-value ratio of 90 percent or above. See Turner (2009).

The effect of housing wealth on saving is not straightforward theoretically, since higher house prices imply both more wealth and higher implicit housing costs going forward (IMF, 2011b).

Specifically, these were the “golden rule,” which stated that over the economic cycle, the government will borrow only to invest and not to fund current spending (equivalently, that public saving will be positive, on average, over the cycle); and the “sustainable investment rule,” which stated that public sector net debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level.

See 2011 U.K. Article IV Staff Report (IMF, 2011a).

As noted by Haldane (2010), three related balance-sheet strategies boosted the added value and risk exposure of the U.K. financial sector: increased leverage (on- and off-balance-sheet); an increasing share of assets held at “fair value” as asset prices rose; and writing deep out-of-the-money options.

This includes tax payments collected from firms and income and national insurance payments by sector employees. See the PricewaterhouseCoopers LLP (2008) study of the U.K. financial services sector for the City of London Corporation.

Given the United Kingdom’s role in global financial markets, corrective policy actions there to prevent future imbalances and mitigate systemic risk could affect partner countries. Coordinated efforts will thus be needed to ensure the consistency of reforms and to minimize unintended consequences (e.g., arbitrage, location shifts, etc.). See IMF (2011c).

This section draws on the 2011 U.K. Article IV Staff Report (IMF, 2011a), the 2011 U.K. Spillover Report (IMF, 2011c), and the 2011 U.K. Financial Sector Stability Assessment (IMF, 2011d).

This section draws extensively on the 2012 U.K. Article IV Staff Report (IMF, 2012).

The FSA is conducting a review of mortgage markets that addresses some of these issues. See FSA (2009).

This would elevate claims of depositors on assets of a failed institution over claims of general creditors.

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