2. Consider Figure 2. Judge the UK's in ation history in an international context; can you think of reasons why the UK has performed as it has? Consider, and try to explain, the recent higher in ation levels in this historical context.

Figure 2: Plots of inflation calculated from Consumer Price Index data for all goods in the UK, US and
Japan. Source: OECD.

     Generally UK’s inflation levels follow patterns of other countries shown on the diagram (US and Japan). All three countries experienced high inflation during mid-70s (although it was less visible in the US and in 1980. However, the peaks were most extreme for the UK, while Japanese and American inflation levels fluctuated less.

     In 1975, due to futile Keynesian demand management attempts, inflation in the UK reached record highs (25%). This was caused by government policies aimed at pushing more demand. Ever since this time, defeating inflation has become a priority for governments, which had to abandon their previous goals of keeping unemployment low. In the aftermath of the 1981 budget, inflation fell for a couple of years.

     Recession in the early 1980s suggested that financial policy was too tight, yet inflation levels did not meet its targets. There were two main reasons for that, one being wage push inflation (trade unions refused to adjust wage behavior) and rising prices of oil (several OPEC countries lowered their production levels and artificially increased prices).

     The last peak was in year 1992. At this time UK has withdrawn from the Exchange Rate Mechanism (ERM), which allowed it to lower interest rates and target inflation more effectively. Since then inflation level in the UK remained quite low and under control until recently. The economic crisis pushed commodity prices up, resulting in inflation rate reaching almost 5% in summer 2011.

Looking at Figure 1, how would you describe the current UK unemployment level?1 Can you explain periods of higher unemployment, and also those of lower unemployment?

Figure 1: Plots of unemployment rates (standardised and claimant count) for a number of major economies

including the UK. Source: OECD Statistics.

     There are two plots for UK unemployment rate – one represents the standardised rate and the other the claimant count. The difference between these two is that the claimant count includes only people who are claiming unemployment benefits, while the standardised rate is the total number of people actively seeking employment. Throughout most of the period represented on the graph, the standardised rate is lower than the claimant count.

     The current unemployment level in the UK is approximately 8.5%, which is its highest level since the early 1990s. The claimant count is much lower and stands at around 5%. Even though these figures are high, UK unemployment is lower than the EU or US levels and UK’s claimant count is much lower than the value for Germany, which is considered as very stable during the current economic slowdown.

     In the past there were two large peaks in unemployment levels in the UK. The first one is a large, rapid increase in the 1980s. This was a result of restructuring of the British industry by the Thatcher government. Government policies were aimed at lowering inflation, even if it meant high unemployment rates. Interest rates and taxes were raised, spending cuts implemented and the economy fell into a recession. People who were hit most severely were those working in mining and manufacturing.

     The recession in the early 1990s was caused by the US savings and loan crisis. In 1993 unemployment level was 10.7%, but since then it began to decrease. Until 2008, when the current recession started, unemployment levels in the UK were quite low, due to a period of steady, stable growth and general prosperity.