Institutional Factors in Economic Policy Change: a Case of Germany and U.K - Research Paper Example

? AL FACTORS IN ECONOMIC POLICY CHANGE: A CASE OF GERMANY AND U.K. No: JEL ification: Word Count: 1623 Political partisanship plays a critical role in the formulation and implementations of monetary and fiscal policies in the U.K. Arguably, every political party (on the left and right) pursue different monetary policies. The difference is outlined in the way and the manner in which different political parties deploy fiscal and monetary policies as the corrective mechanisms for handling macroeconomic challenges. For instance, the leftist parties are proposed to counter-cyclical financial policies. On the other hand, the rightist party interests prefer pro-cyclical fiscal mechanisms. Politics therefore plays a critical role in influencing, formulating and enacting financial policies of a state. Key words: political partisanship, monetary and fiscal policies, financial policies Background of the study In the twenty first century, governments’ fiscal policies have experienced a great deal of public and scholarly consideration. Despite this attention, fiscal and monetary policies have undergone some challenges such as the link between the acknowledged association between the ideological proclivities of governments and their predisposition to adopt deficit spending (Carlsen, 1997, p.145-7). In nutshell, some governments have recklessly engaged in deficit spending while other governments do not believe in this deficit spending but rather are seen as fiscally prudent. This characterization of enthusiast influences on fiscal policy has small amount of support in term of empirical support from scholars. There are far more multifaceted relationship that exists between fiscal policy and partisanship, an affiliation that has been varied over time (Roubini and Sachs, 1999, p.924). Statement of the problem Political neutrality is perceived as the best practice in determining the independence and reliability of the financial and fiscal decisions by the United Kingdom. This is because the fiscal critical policies formulated will at the interest of economic stability. However, politics influences the economic policies by changing the monetary and fiscal policies in order to attain personal or politicized outcomes aimed at reining the state. These adversely affect the economic and financial performance of the country. Research Questions and Objectives of the study The general objective of this study is to determine the influence of partisanship and politics on the economic performance. More specific, the study aims at; Establishing the relationship between partisanship and economic performance Determining the differences between partisanship in Germany and United Kingdom Determining the degree to which partisanship and politics impacts on monetary and fiscal policies This research seeks to answer the following questions; Is there a positive relationship between economic performance of U.K/Germany and partisanship? Are the partisanship of Germany and U.K different? Is partisanship and politics essential in enactment and implementation of monetary and fiscal policies of these two countries? Research assumptions/hypothesis Economic performance and partisanship have a strong positive relationship. There is no significant difference between partisanship in Germany and U.K. Partisanship influences the monetary and fiscal policies right from enactment to implementation stage. LITERATURE REVIEW The government of the United Kingdom has introduced fundamental steps aimed at strengthening their fiscal and monetary policy. Fiscal policies of the U.K. are firmly directed towards achieving sound monetary and financial policies for both long-term and short-term economic cycles. Fiscal and monetary policies of the United Kingdom provide policy frameworks and platforms for economic stability, economic growth, balance payment accounts, and creation of sustainable employment policy (Schmidt, 2006, p.78-9). Quality internal and external scrutiny of fiscal and monetary policies is significant in achieving aggregate financial analysis to enhance the understanding of the central government of fiscal and monetary issues. During Mr. Brown’s tenure as the chancellor of the Bank of England, the central bank opted for ‘Golden Rule’ Fiscal policy, a policy favoured by the Labour Party. According to this rule, government’s borrowings are strictly restricted for investing in economically viable projects over the entire economic life of the investment (Schmidt, 2010, p.79). The current expenditures should only be financed by the tax revenues raised over the financial period. This allows for financial stability; defined by the financial ratios and nation income statistics. Besides, the United Kingdom seeks to adopt the commonly referred to as the ‘Sustainable Investment Rule’. According to this golden rule, the national debt should be kept at a level prudently below forty percent of the real GDP. This followed the great recession and the euro financial contagion which called for Keynesian stimulus package and the balancing of financial records was attainable on the onset of economic recovery (Douglas, 2002, p.373). Fiscal Policy: The generally and widely-accepted effect of partisanship and politics on the fiscal policies of United Kingdom is the interventionist economic policy approach to financial management, a policy proposed by the leftist parties. Similarly, the right-wing politicians advocates for non-interventionist plus a restrictive approach to fiscal policies. Therefore, a government formed by the leftists will prefer running a deficit budget while the rightist dominated government will operate a balanced or surpluses budgets (Schmidt, 2006, p.78-9). Political partisans and the political parties will opt for the adoption of their ideologies and political policies in the core sector of the economy, which are the financial sectors (determined by fiscal and monetary tools). The foundation of fiscal policies preferred by these parties is as follows. The leftists and their constituent parties opt for a fiscal policy based on the Keynesian counter-cyclical fashion. This is an indication that the leftists prefer stimulative fiscal policies during economic recession (high employment period). On the other hand, restrictive fiscal mechanisms are preferred in solving economic challenges in periods of high inflation characterized by low employment. By adopting stimulates economic package to counter the great recession, the leftists assist their followers and constituents, with the unemployed members of the United Kingdom possibly bearing the greatest burden and costs closely linked with the economic meltdown (Carlsen, 1997, p.145-7). Similarly, by introducing restrictive fiscal policy in periods of economic booms or full employment, the leftists depicts the ability of the central government of the U.K. to adequately respond to unforeseen economic recessions through minimization of debt build-ups. This results into crowding out effect, occurring at higher interest rates and expensive cost of borrowing. As opposed to the leftists, the rightists pursue a very different political and financial policy by opting for Classical economic approach (Roubini and Sachs, 1999, p.932). During economic boom, rightists prefer stimulative fiscal mechanisms through cutting down on incomes domestic taxes but without reducing the government expenditures over the same period. By reducing taxes, it provides a greater advantage to the politically neutral constituents and at the same time minimizing alienation of costs which would have resulted from expenditure cuts (Schmidt, 2006, p.78-9). During high inflations, the rightists apply more restrictive fiscal policies than the leftists. Counteracting the impacts of automatic stabilizers in the economy helps in weakening economic forces pushing for significantly higher wages to the employees, thus pushing the effective demand up, a move which is immediately followed by high commodity prices (Jakob de and Jan-Egbert, 2004, p.168). Monetary Policy: partisanship significantly influences the monetary policy of the United Kingdom. This calls for independence of the central bank of England from the central government’s influence. Since the election of the central bank officials are highly appointive positions, it is noted that such a move can potentially have political influence on the monetary policy decisions. As indicated by empirical and theoretical studies, it is only through claiming self-regulation and independence in the central banking unit that the government will be successful in lowering inflation rate at zero additional cost (Jakob de and Jan-Egbert, 2004, p.168). The proponents of bank independence identified that such isolation of the central bank from political partisans’ shocks allows banks and other financial institutions to focus on price stability without any undue influence from the political power-horses. Thus, when the state operates in deficit, to stimulate the economy, the central bank of England will have to raise the interest rates to slow down the economy. But such a policy mechanism will only be practical with more independent financial institutions (Roubini and Sachs, 1999, p.921-4). However, the monetary policy of the banking institutions should be complementing the political fiscal policies of the government. The Germany politics is dominated by two political parties: the conservative (CDU) Christian Democratic Union and the leftist (SPD) Social Democratic Party. In Bavaria, the largest federal state in Germany in terms of geographical area, the CSU represent the conservatives as opposed to their sister party CDU. Smaller parties such as (FDP) Free Democratic Party and (GREEN) Green party have also played a significant role in coalition matters (Boix, 2006, p.65). In many industrial countries, electoral cohesion decline after the cold war period. In Germany, government ideology was significant in determining economic policies in the federal level most during 1970s and 1980s. The leftist Social Democratic Party-led government applied expansionary economic policies in the 70s, while the conservative CSU/CDU-led governments applied restrictive economic and fiscal policies in the 80s. Following the German Reunification in 1990, the CSU/CDU-led governments did not insist on practicing restrictive economic policies, or rather they focused on increasing public spending and transfers. The Then-chancellor Helmut Kohl promoted incorporating the East German into the current unified nation. This reunion change the economic dynamics of the whole country hence the fiscal policy of the country (Douglas, 2002, p.372). In regards to the monetary policy, Germany aggregate monetary growth seems to increase and declines before and after elections respectively especially when the central government had a quite a number in the Bundes-bank council at the start of the election period or when the political landscape divert to favor the federal government for the duration of the pre-election period. In Germany, politicians do not affect aggregates directly. This is due to institutional limitations and restriction such as the Independence of the country’s central bank. For this reason, government ideology and electoral motives are more likely have influence monetary policy only when the independency of the central bank is not compromised and hence subject to directives of the central government (Boix, 2006, p.65). Whatever the case may be, government ideologies affect the appointment of the central government board and specifically the governor of the central bank. A political party may to influence the nomination of the council members of the central bank. These nominated members might represent the political interest of the political party hence the resultant decision of the central bank council might favor a political party. RESEARCH METHODOLOGY Site, Population and Sample Size The target groups (population) for this study are the government and inter-state financial institutions. In particular, the research will focus on monetary authorities and institutions such as Central Banks and depository bodies in U.K. and Germany. The setting of the study will be in major urban cities which have a large number of financial institutions. a total of 25 institutions and 5 financial regulatory authorities will be sampled. Data Collection This research relies on two sources of data that is primary and secondary data. Primary raw data was collected using questionnaires and interviews. The information will be collected from administrators and directors of leading financial institutions. These primary methods of data collecting are preferred because they are economical and save time. Secondary data set will obtained from books, journals, newspapers, newsletters, magazines, and other secondary publications. Data analysis The primary data collected will be sorted, classified and analyzed using the descriptive and empirical statistical methods. These information relating to partisanship and economic policies will be tabulated using statistical software (SPSS), and presented in form of charts, bars, graphs, percentage, numeric dispersion and tendencies, and frequency distribution. Time-Frame 1. Chapter One: Introduction 2 weeks 2. Chapter Two: Literature Review 2 weeks 3 (a) Chapter Three: Data Collection 1 month (b) Data Analysis 2 weeks (c) Presentation 3 days 4. Chapter Four: Finding and Results 1 week 5. Chapter Five: Conclusion and Recommendation 1 week Bibliography Boix, Carles (2006), Partisan Governments and Macroeconomic Policies in OECD Countries. Paper presented at Annual Meeting of the America Political Science Association, San Francisco. P.65-68. Carlsen, Frederick (1997), Counter-fiscal Policies and Partisan Politics: Evidence from Industrialized Countries. Applied Economics 29: p.145-151. Castles, Frank G. and Peter Mair (2004), Left-Right Political Scales: Some ‘Expert’ Judgements. European Journal of Political Science 12: 73-88. Research 30/2: 155-183. Haan, Jakob de and Jan-Egbert Sturm (2004), Political and Institutional Determinants of Fiscal Policy in the European Community. Public Choice 80: p.157-172. Hibbs, Douglas A. (2002) Partisan Theory after Fifteen Years. European Journal of Political Economy 8: p.361-373. Roubini, N. and J. Sachs (1999), Political and Economic Determinants of Budget Deficits in the Industrial Democracies. European Economic Review 33: p.903-938. Schmidt, Manfred G. (2010) When Parties Matter: A Review of the Possibilities and Limits of Partisan Influence on Public Policy. European Journal of Political. P.78-9. Read More