The Effect of Economic Cycles on Financial Asset Prices in the UK

An economic cycle

An economic cycle is a fluctuation in the economy which naturally occurs between periods of economic growth where there is expansion and periods of economic recession when there is a contraction in the country’s economy (Rey 1). A stage in the economic cycle is determined differently depending on the factors that influence the economy of the country. Factors like the gross domestic product, employment levels and the levels of interest are used to tell the stage of the economy in an economic cycle. The fluctuations in the economy affect the country’s economic trends which are characterized by cycles driven by the forces of demand and supply affecting prices in the market. The structure of the economy and the behavior of companies and households influence the occurrence of economic cycles in the UK when they change with time.

Changes

In the UK, economic cycles have occurred severally in the past with major recessions greatly affecting its economy in the past 50 years. The recessions in the UK are defined by the occurrence of negative growth of the economy in successive quarters which are measured seasonally using the real GDP figures from one quarter to the next. During these cycles, consumer income and consumption keeps changing over time. The rate of production growth also varies with the pace of economic fluctuation.

Impact

Fluctuations in the economy have a great impact on the trend of financial asset prices. Financial assets obtain their value from contractual claims (Borio 1). Their long-term trend in their prices is influenced by fluctuations in the economic cycles. Examples of financial assets include bank deposits, cash, bonds, and stocks. Most of these financial assets need to be converted into cash to obtain their monetary value because it is not pre-determined (Borio 1). The values of financial assets keep fluctuating because it is influenced by fluctuations in the economic cycles.

During the economic cycle

During the economic cycle, the growth of the economy undergoes various stages that affect the trend of financial asset prices. During the phase of expansion, a rapid growth in the economy occurs where the rate of production also increases. The prices of financial assets are relatively low at this phase since interests are also low. The cycle continues to increase to a maximum level in the peak phase which causes economical imbalances which are corrected by the next phase of contraction. During this phase, the rate of growth is tentatively slowed down with marked drop and stagnation of prices for financial assets. The economy then gets its recovery through the trough phase by hitting a low point in its growth.

The government of UK manages the economic cycle

The government of UK manages the economic cycle using the fiscal policy. For example, when the economic cycle is at the trough phase, the Central Bank of London will lower its interest rates which will eventually lower the prices of financial assets in the market (Carvalho et al. 1). On the other hand, it raises the prices to curb the expansion of the economy which will lead to an increase in the prices of financial assets. For example, the Bank of London increased its interest rates in 2017 from 0.25% to 0.5 to control the economic recession (Carvalho et al. 1).

The use of monetary policies

The use of monetary policies by the Central Bank of London to control the economic cycles affects the trend in prices of financial assets. The monetary value of financial assets is either reduced or increased in the market to affect its availability in the market (Anderson et al. 64). The change of these prices is caused by the occurrence of economic cycles which makes the government through the Central Bank of London to use the monetary policy affecting financial assets. The policies set are aimed at keeping the capital account to remain closed or open and control the financial conditions within the country (Rey 1). The outcome eventually affects the prices of financial assets since they are also changed to curb the economic crisis. An economic recession leads to a widespread decrease in the economic activities in the country. The Central Bank of London lowers the prices of financial assets to increase the demand for credit by borrowers (Anderson et al. 64). The price of government bonds also decreases to make them affordable to investors. Other financial assets are also affected in a similar way to make them affordable to the buyers.

The long-term trend of financial assets

The long-term trend of financial assets is also affected during peak phases of the economic cycle. A contractual fiscal policy affects the prices of assets by increasing them to control the economic crisis (Grinin et al. 1). The policy is applied due to fluctuations in the economy and aims to maintain and control the economy at an equilibrium level. The price of financial assets inflates in the market. Assets like stock become expensive to decrease the buyer power and stabilize the economy (Grinin et al. 1). The increase in prices for financial assets affects its capability of maintaining a long-term trend in its prices.

Conclusion

Economic cycles in the UK greatly affect the long-term trend in financial asset prices due to the fiscal policies set tend to maintain and control the fluctuations. Therefore, maintaining a steady equilibrium in the trend becomes a challenge.

Works Cited

Anderson, Nicola, and Francis Breedon. “UK asset price volatility over the last 50 years.” Journal of Risk Spring 2 (2000): 63-77.

Borio, Claudio. ”The financial cycle and macroeconomics: What have we learnt?.” Journal of Banking & Finance 45 (2014): 182-198.

Carvalho, Carlos, Stefano Eusepi, and Christian Grisse. ”Policy initiatives in the global recession: what did forecasters expect?.” (2012).

Grinin, Leonid, Arno Tausch, and Andrey Korotayev. ”Economic cycles, crises, and the global periphery.” (2016).

Rey, Hélène. Dilemma not trilemma: the global financial cycle and monetary policy independence. No. w21162. National Bureau of Economic Research, 2015.