Working Paper No. 566
By Stephen Millard
In line with most of the developed world, the United Kingdom experienced in 2008–09 its worst recession since the Great Depression of the 1920s and 30s: the Great Recession. But despite the 6% peak-to-trough fall in output (as measured by real gross value added at basic prices) the unemployment rate only rose from 5.2% in 2007 Q4 to 8.4 in 2011 Q3. This muted response is often attributed to the flexibility of the UK labour market and, in particular, the willingness of UK workers to see their real wages fall. This paper uses an estimated DSGE model of the UK economy to investigate this hypothesis, assessing which shocks were largely responsible for the Great Recession and the extent to which the effect of these shocks on unemployment would have been worse had the UK labour market responded less flexibly.