UK productivity: the long and the short of it

The level of productivity is an important macroeconomic indicator that informs monetary policy decisions. Since the 2008 financial crisis, UK productivity has plunged and remained below its pre-crisis level for more than a decade. Evidence that the European debt crisis was generated by a fall of productivity and subsequent current account deficit of South euro area countries raises challenging questions about the impact of productivity on the UK’s business cycle. We measure this impact by accounting for both permanent and transitory shocks to total factor productivity (TFP) and investment-specific technology (IST). Our results suggest that permanent positive TFP and IST shocks worsen the trade balance by increasing domestic absorption and appreciating the real exchange rate. However, the real exchange rate itself has no effect on net trade. In contrast, cyclical productivity shocks do not impact trade or the real exchange rate. Finally, our findings show that the financial crisis had a long-run negative impact on both output and trade.