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Prior to the global financial crisis of 2008, the UK had the largest banking sector asset to GDP ratio among large countries, and had experienced rapid real property price increases as well as a persistent current account deficit in the preceding decade. These factors, together with its role as an international financial centre, made the UK economy particularly vulnerable to the onset of the global financial crisis. Although the initial drop in real GDP was steep, we provide evidence that the economy has weathered the financial storm better than many feared, and has fared no worse than its peer group of major economies. In this paper we assess the reasons underlying this outcome, including the possibility of exaggerated vulnerabilities, global economic recovery, the flexible supply side of the UK economy, as well as fiscal, financial and monetary policy interventions. Our analysis suggests that all of these factors played a role in cushioning the impact on the UK real economy, leading to a more benign outcome than most observers expected.

At the onset of the global financial crisis, in the second half of 2007, the UK looked to be more heavily exposed to the emerging problems in the banking sector than its peer group of large industrialised countries. There were a number of reasons for this. First, its financial sector was much larger in relation to the size of its economy than any other G7 economy (Fig. 1). Second, there were worries that the UK housing market might share some of the vulnerabilities that had afflicted the US housing market through the rapid expansion of sub-prime lending, adding to the weaknesses in the UK's financial system (Fig. 2). Third, a British Bank – Northern Rock – was one of the early major casualties of the financial crisis. And fourth, the UK was running a current account deficit of around 3% of GDP and was potentially vulnerable to a cessation of capital flows to finance the deficit (Fig. 3). Full-size image (32 K)But more recent trends point to a more optimistic outcome for the UK real economy. The initial rebound in output in the UK was stronger than previous recoveries, and also outpaced a number of other peer group economies.1 Employment has been more resilient and company failure rates much lower than earlier downturns. Though there are still some uncertainties surrounding the outlook for growth and inflation has been surprisingly high, unemployment did not reach the level of over 3 million which was being widely forecast in early 2009.2 The main issues concerning the performance of the UK economy are therefore why it has survived the crisis so well, rather than why it has done so badly. In this paper we assess why the worst case scenario did not materialise and investigate four possible explanations: the possibility that UK vulnerabilities to the crisis were exaggerated; the effectiveness of banking, fiscal and monetary policy interventions; the role of the supply side; and the impact of the recovery of the global economy. Our analysis suggests that all four factors played a role in cushioning the UK economy from the shocks associated with the onset of the global financial crisis. The paper is divided into three main sections. The first section considers the performance of the UK economy through the crisis and into the early phase of the recovery. While the current vintage of output data shows a relatively deep recession, there has also been a relatively strong rebound in real GDP and employment has been surprisingly resilient. The second section considers the four broad areas of explanation highlighted above. And the third section of the paper considers the economic outlook for the UK and current policy dilemmas in the aftermath of the financial crisis.