In today’s interdependent markets, the economy of one country is inextricably linked with that of another. For instance, the collapse of the banking sector in Iceland had a substantial impact on the British economy and the currency volatilities of the Euro have had implications far beyond the Euro zone. In this essay, I will examine how British macroeconomic policies have attempted to reduce the damage of recent economic turbulence in the US on the UK economy.
Macroeconomics, policies that aim to improve economic growth, maximise national income and raise the standard of living for citizens, have four main methods: full employment, inflation, balance of payments, equilibrium of supply and demand. In this essay I will look at: inflation and taxation. I will describe the policies followed, how they were put into practise and whether they have been effective at stabilising the British economy in this time of significant international turbulence.
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To analyse the different policies of the United Kingdom you first have to know what all governments want from their macroeconomic policies. Research shows that all governments have 4 major targets when it comes to macroeconomics. These are: 1. low inflation CPI=2% 2. Strong economic growth, but, not inflationary growth. Increasing long run trend rate of growth 3. reduce unemployment 4. avoid large deficit on current account balance of payments One of England’s policies was to nationalise a central bank (the UK has had the Bank of England set up in 1694, made independent in 1997), which sets monetary policies for the UK.
Set up in 1997 one of its main goals and a macroeconomic objective of this bank was monetary (controls the supply of money into the economy and sets interest rates to control the supply and demand for money in an economy) stability. Monetary stability means stable prices, low inflation, and confidence in the currency. Stable prices are defined by the Government’s inflation target, which the Bank seeks to meet through the decisions taken by the Monetary Policy Committee. Inflation is the rate of change of prices for goods and services.
Inflation is a bad thing because it means that the purchasing power of the consumer is weakened. Monetary policy can be used to curb inflation by using tools such as interest rates and the input and output of money. A principal objective of any central bank is to maintain the value of the currency in terms of what it will purchase. Rising prices, inflation (increase in prices, fall in the purchasing value of money), reduces the value of money. Monetary policy is directed to achieving this objective and providing a framework for non-inflationary economic growth.
As in most other developed countries, monetary policy usually operates in the UK through influencing the price at which money is lent – the interest rate. However, in March 2009 the Bank’s Monetary Policy Committee announced that in addition to setting Base Rate, it would start to inject money directly into the economy by purchasing assets often known as quantitative easing. This means that the instrument of monetary policy shifts towards the quantity of money provided rather than the price at which the Bank lends or borrows money.
Low inflation is not an end in itself. It is however an important factor in helping to encourage long-term stability in the economy. Price stability is a requirement for achieving a wider economic goal of sustainable growth and employment. High inflation can be damaging to the performance of the economy. Low inflation can help to promote sustainable long-term economic growth The consumer price index (CPI) measures inflation each month in the European Monetary areas as a whole and individually measures and compares each country.
The CPI covers all private households. Latest data from CPI January 2011 indicates that annual inflation was 4%, up from 3. 7% in December and remaining well above the Government’s 2% target. The largest upward pressures came from the following: fuels and lubricants, restaurants and cafes, alcoholic beverages, furniture and furnishings and purchase of vehicles. The largest downward pressures came from recreation and culture, miscellaneous goods and services and clothing and footwear.
The Bank of England believes that the latest rise in inflation was due to the VAT rise, the past weakness of the pound and recent rises in commodity prices. The Bank expects UK inflation to rise towards 5% in the coming months. As an internationally comparable measure of inflation, the CPI shows that the UK inflation rate in December 2010, at 3. 7%, was above the figure for the European Union as a whole of 2. 6%. From these figures above we can see that England is not doing as well as its neighbours in keeping inflation low which is a tool to keep the economy stable.
Looking towards graph (1a) we can easily see that the inflation rate hasn’t been stable or going up. In august 2009 inflation rates were at 1. 1 meaning not very high and in August the next year it was up to 3. 1. Meaning that the governments methods of keeping inflation low by purchasing assets is not effective enough to keep inflation to the ideal government rate of 2%. Fiscal policy involves the Government changing the levels of Taxation and Govt Spending in order to influence Aggregate Demand (AD) and therefore the level of economic activity.
Basically, fiscal policy aims to stabilise economic growth, avoiding the boom and bust economic cycle. Fiscal policy is based on the theories of British economist John Maynard Keynes. Also known as Keynesian economics, this theory basically states that governments can influence macroeconomic productivity levels by increasing or decreasing tax levels and public spending. This influence, in turn, curbs inflation (generally considered to be healthy when at a level between 2-3%) During Gordon Brown’s time as Chancellor, the Labour Party officially adopted the ‘Golden Rule’ of fiscal policy.
The Golden Rule states that over the full economic cycle, the government should only borrow to invest only for future needs. Current needs should be met by tax revenues. This should allow for stable finances as defined by the ratios of public sector net worth, debt and current expenditure to national income. In conjunction with the Golden Rule, the UK government also seeks to follow the Sustainable Investment Rule, which should keep national debt at a sensible level currently set at 40 per cent of GDP. In other words, no government should borrow more than 40% of its annual GDP.
By the end of 2008 estimated public debt had already risen to 42 per cent, and could rise to 70 per cent of GDP by 2010, meaning that the Sustainable Investment Rule has been broken. This is shown on the graph. If we look at the CPI line we can see that public debt is rising extremely fast. It was rising so quickly because of the global recession that had caught the world by storm. From this we can say that the fiscal policy in England was not strong enough to withstand a great depression. This means that it was not effective enough as it did not keep public debt low and did not help inflation either.
In conclusion it can be said that England has a weak Monetary and Fiscal policy which is too reliant on other countries’ economies. If England were to lower VAT it would stimulate growth further and create a more active market therefore helping the economy as a whole. The objectives of the government are too idealistic as the country believes that all the other economies around the world will continue to do well. If the U. K. was to adopt a system in which they were not as reliant on other countries’ economies their macroeconomic policy would be safer from economic recessions.