The 1980s recession in the UK: A business cycle accounting perspective

Abstract

This paper applies ‘Business Cycle Accounting’ methodology introduced by Chari, Kehoe and McGrattan [Chari, V.V., Kehoe, P.J., McGrattan, E.R., 2007. Business cycle accounting. Econometrica 75 (3), 781–836] to the UK economy. In particular, I examine the cyclical episode from 1979 to 1989. The chosen method enables me to decompose fluctuations in aggregates to isolate the effects corresponding to different distortions in the underlying model. I find distortions in the labor–leisure decision to play a significant role in both the recession in the early 1980s and the subsequent recovery of the UK economy. Furthermore, scenario simulations show that the improvement of the labor wedge was necessary for the recovery of the UK economy starting in 1984. After reviewing evidence on the effects of the new labor market policies introduced by the Conservative government under Margaret Thatcher on union density and collective bargaining, the results suggest that the reforms were essential for the improvement in economic performance. Future research on the period should therefore focus on modeling the labor market distortions and the reforms that were intended to reduce them.