In the decade leading up to the recession, robust procyclical government spending—financed partially by revenue flows from the financial and housing sectors and partially by debt—accumulated on the UK’s AAA sovereign credit rating, and the UK entered recession in 2008 with one of the highest structural budget deficits in the OECD. The UK suffers from all the usual problems associated with post-industrial economies, including an aging population, which causes climbing welfare bills and heath care costs in relation to tax revenues. The record level of public debt, along with the emerging risk of sovereign default in the eurozone periphery, pushed CDS spreads on UK bonds higher than those on, for example, German bunds, raising doubts over whether the UK’s fiscal standing was at odds with its AAA rating. A large proportion of the UK’s government bonds are held by foreign investors (in contrast to Japan, for example, which also has a high fiscal deficit, but where most debt is bought domestically) making the UK particularly vulnerable to dips in investor confidence. Nonetheless, most UK bonds are issued in GBP and so are not vulnerable to foreign currency shocks. The UK also has the advantage of relatively long maturities on most of its debt, reducing the pressure to refinance in the near term.
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