Performance of the British Government and the Bank of England - Essay Example

Performance of the British Government and the Bank of England in Running the British Economy between November 2008 to November Student Number Course Name and Number Name of Professor Date of Submission Number of Words: 2,171 Table of Contents I. Introduction ……………………………………………………… 3 II. Success of British Government and the Bank of England in terms of Running the British Economy between November 2008 and November 2010 …………………………. 3 a. Gross Domestic Product (GDP) ……………………… 3 b. Unemployment Rate …………………………………… 4 c. Balance of Payments ………………………………….. 4 d. Price Stability – Inflation, CPI Index, and GDP Deflator ……………………………………………. 5 d.1 Inflation ………………………………………… 5 d.2 CPI Inflation ……………..……………………. 6 d.3 GDP Deflator ………………………………….. 7 III. Macroeconomic Policies used by the British Government and the Bank of England to ensure a Successful British Economy …………………………………………………… 7 a. Fiscal Policy ……………………………………………… 7 b. Monetary Policy …………………………………………. 10 IV. Conclusion …………………………………………………………. 11 Appendix I – UK GDP Historical Trend …………………………………. 12 Appendix II – Historical Trend of UK Unemployment Rate …………… 13 Appendix III – Historical Trend in UK’s Balance of Payments ……….. 14 Appendix IV – Historical Trend of UK Inflation Rate ………………….. 15 Appendix V – Historical Trend of CPI Goods and Services …………. 16 Appendix VI – Decrease in Government Spending Decreases GDP . 17 Appendix VII – Decrease in GDP Decreases Employment Opportunity ............................................ 18 Appendix VIII – Increased GDP Increases Employment Opportunity . 19 References ……………………………………………………………… 20 - 21 Introduction Despite the challenges in the global economic condition, this study will discuss how well the British Government and the Bank of England was able to manage UK Economy. As evidences of a successful economy, significant events that occurred in Great Britain between November 2008 and November 2010 will be provided in this study. Eventually, the macroeconomic policies used by the British government and the Bank of England to ensure a successful British Economy will be described and evaluated based on macroeconomic theories. Success of British Government and the Bank of England in terms of Running the British Economy between November 2008 and November 2010 The success of the British Government and the Bank of England in terms of managing the British economy can be noted by examining the trends of Gross Domestic Product (GDP), unemployment rate, balance of payment, and price stability between November 2008 to November 2010. Gross Domestic Product (GDP) The main function of Gross Domestic Product (GDP) is to measure the total economic activities that occur within a country (Office of National Statistics, 2010 a). Although the GDP trend in UK between the 3rd quarter of 2008 up to 2nd quarter of 2009 is sloping downwards, the GDP trend has been constantly increasing since the 3rd quarter of 2009 up to the present time. In line with this, the downward and upward sloping curve in UK’s GDP trend suggests a weak and strong economic condition respectively. (See Appendix I – UK GDP Historical Trend on page ) Even though the total electricity, gas and water supply output and agriculture, forestry, and fishery output decreased by 0.2% and 0.3% respectively, the overall UK GDP during the 3rd Quarter of 2010 increased by 0.8% because of the significant increase in the total service output by 0.6 %, total production output by 0.6%, and construction output by 4.0% (Office for National Statistics, 2010 b). Unemployment Rate Unemployment rate in UK is pertaining to individuals who are not able to have the opportunity to be employed. Since November 2008, unemployment rate in UK has been constantly increasing until June 2009. Between July 2009 up to the present time, unemployment rate in UK has been going through a series of ups and downs between the rates of 7.7 to 8.0% (Office for National Statistics, 2010 d). (See Appendix II – Historical Trend of UK Unemployment Rate on page ) Although the number of people who are employed in UK has been continuously decreasing since November 2008 up to February 2010, employment rate has been increasing since then. Increased in employment rate for the past 5 months is a sign of better economic performance in the British economy. Balance of Payments Balance of payments is referring to the monetary transactions related to import and export of goods and services, financial capital, and financial transfers between UK and other countries around the world (Sloman, 2004, pp. 516 – 517). Since November 2008, UK’s balance of payments has going through a cycle of ups and downs. (See Appendix III – Historical Trend in UK’s Balance of Payments on page ) Between the 4th quarter of 2010 up to the 2nd quarter of 2010, the balance of payments deficit in UK has decreased by 1% (Office for National Statistics, 2010 e). It means that even though the trend of UK’s deficits goes up, the British government is able to make good use of its fiscal and monetary policy in terms of managing its current account deficits. Price Stability – Inflation, CPI Index, and GDP Deflator Inflation Rate Over a period of time, inflation rate is referring to the increase in the price levels of economic goods and services (Doty & Turner, 2009, p. 64). Specifically the inflation rate between November 2008 to September 2009 has gone down from 4.1% to 1.1%. Between September 2009 to January 2010, inflation rate rises from 1.1% up to 3.5%. Since then, trend of inflation rate was bullish between 3.0% to 3.8%. Since the Bank of England was able to maintain UK inflation rate at 3.1% between July 2010 up to the present time, we can say that the Bank of England was able to perform a good job in terms of controlling its inflation rate from increasing more than the 3.1% level (Office for National Statistics, 2010 f). (See Appendix IV – Historical Trend of UK Inflation Rate on page ) In the long run, a very high inflation rate could harm the entire British economy. Given that the market prices of basic commodities increases, people will start experiencing the negative socio-economic consequences of having the need to pay more money when purchasing basic commodities and services (Rogers & Wang, 1993). In other words, the purchasing power of money decreases (Doty & Turner, 2009, p. 64). Likewise, a significant increase in the price level will make it more difficult for the local companies to compete in the global markets. Therefore, investors are more likely to become uncertain about investing in countries with high inflation rate. Consumer Price Index (CPI) Inflation Consumer price index (CPI) is referring to the average prices of economic goods and services that are purchased by a common family (Brux, 2008, p. 339). Specifically the rate of CPI is commonly used in calculating significant increase or decrease in the market prices of basic commodities and services over a given period of time. Since CPI is used in measuring the average price of basic consumption of goods and services, CPI can be used in determining the estimated cost of living. Between 4th Quarter of 2008 to 2nd Quarter of 2010, percentage changes of CPI goods and services in UK is showing a downward trend as compared to a year earlier (Bank of England, 2010). It means that the average prices of goods and services that are purchased by each family decreases. The downward trend can be explained by the negative GDP growth and high unemployment rate between the 4th Quarter of 2008 to 2nd Quarter of 2010. (See Appendix I – UK GDP Historical Trend on page ; Appendix II – Historical Trend of UK Unemployment Rate on page ; and Appendix V – Historical Trend of CPI Goods and Services on page ) GDP Deflator GDP Deflator is referring to the “ratio of nominal GDP to real GDP wherein nominal GDP is the current output valued at current prices and real GDP is the current output valued at base-year prices” (Mankiw, 2009, p. 536). Given that GDP deflator reveals the market prices of goods and services within the domestic market and that CPI reveals the market prices of all consumer goods and services purchased by the buyers, economists and government policy makers are strictly monitoring the GDP deflator and the CPI in order to measure how fast the market prices of basic commodities are rising. During the 2nd quarter of 2010, the nominal GDP increased by 1.3% which is 1.2% increase in the real value of GDP and 0.2% increase in the GDP deflator (Bank of England, 2010, p. 18). In relation to improvements in the stock cycle, government spending, business investments, and increase in household spending, the rationale behind the improvements in the British economy was due to the increase in real GDP by 2% since the 3rd quarter of 2009 up to 2nd quarter of 2010 (ibid). Macroeconomic Policies used by the British Government and the Bank of England to ensure a Successful British Economy Fiscal Policy There are many ways in which the British government could make use of fiscal policies in order to maintain the success of British economy. As part of the fiscal policy, the HM Treasury on behalf of the British government is aiming at being able to maintain a sound macroeconomic condition by maintaining a low level inflation rate. In general, the movement in government spending either creates of lessens the available job opportunities. In case the British economy slows down, the amount of tax collected by the British government also decreases. In line with this, a lesser tax collection means lesser government spending. This allows the GDP demand curve to move to the left causing a lesser government spending and lower prices of GDP. (See Appendix VI – Decrease in Government Spending Decreases GDP on page ) Large sum of government deficits could seriously hurt the entire British economic condition in the long-run. In case the British economic experts strictly suggest not to increase the government deficit, the British government at this point should not totally rely on the option of increasing the government spending as a way of creating more jobs and reducing the high unemployment rate. An economic rule states that the government budget should be balanced with the whole economic cycle and that borrowing should be used only to finance capital spending (IFS Green Budget 2007). It means that the government budget should not be used in covering the current gaps between current government spending and tax revenues. Instead of using the government collected taxes in creating new job opportunities, the best option is to allow the decrease in demand to settle at its equilibrium point until the economy starts to rise again. In this case, the British economic experts should take a neutral position by allowing the unemployment rate to respond to the real economic situation. Given that the British government decreases or limit its government spending, decrease in the demand for GDP is likely to occur. As a result, decrease in demand for GDP also decreases the job opportunities for the local citizens. Since the local people have lesser cash on hand, the price of goods and services in the country also decreases so as to enhance purchasing activities. Therefore, the British government can effectively decrease a high inflation rate or be able to control the high inflation rate within a certain level. (See Appendix VII – Decrease in GDP Decreases Employment Opportunity on page ) As soon as high inflation rate goes down, the British government should start using its government revenues in order to boost the British economy. In line with this, when the British economic experts decided to increase the government spending as a way of preventing high unemployment rate, the demand curve of goods and services will shift to the right until it reaches a point of equilibrium. This creates a greater output in the country’s Gross Domestic Product (GDP). (See Appendix VIII – Increased GDP Increases Employment Opportunity on page ) The British government can create a better quality life-style for the local citizens by controlling, restructuring, and imposing fair taxes to low income earners. Income taxes based on the amount of income is better than imposing a fixed tax rate for all. This type of income taxation scheme should based on the level of income each family is earning, the type of family – whether the couple has kids, or is a single parent, or never been married, etc. (Hussain, 2004). This concept could effectively narrow the gap on unequal distribution of wealth among the local citizens by releasing tax burden on poor citizens. Fiscal policy control by setting a higher tariff rate on imported goods can be implemented to protect the growth of domestic market. A higher tariff rate imposed on imported items, despite the free market trading worldwide, would trigger the demand on foreign goods to decrease. This will encourage the local citizens to patronize their own products. The increase in the local demand on goods and services would create more job opportunity for the local citizens and a higher tax collection to cover up a ballooning budget deficit of the country. Monetary Policy When necessary, the Bank of England can control the country’s money supply and interest rates in order to maintain a maximum level of employment, a stable price and avoid high inflation rate by controlling the interest rates. In line with this, a high interest rate will encourage more people to save their money in banks given that the British economy is unstable. In case the Bank of England sets its interest rate low, more people will be attracted to invest their money in business or loan from banks in order to establish their own business. Therefore, more people will have the opportunity for employment. The Bank of England can avoid high inflation rate by tightly controlling its money supply. This particular monetary strategy can be used in creating short-term employment opportunity. Tightly controlling the money supply limits the amount of money that circulates in the country which is necessary in terms of increasing the purchasing power of money. Given that the real value of money is high, more people will be attracted to invest in UK. As a result, more people will be able to find better job opportunities. Considering this point-of-view, unemployment rate is likely to decrease. Conclusion The British Government and the Bank of England was able to effectively manage UK economy since the GDP growth rate increased by 3%. Other indicators suggesting a well managed economy includes: slightly decreasing unemployment rate, decrease in balance of payments deficit, and highly controlled inflation rate. *** End *** Appendix I – UK GDP Historical Trend Source: Office for National Statistics (2010 b) Source: Office for National Statistics (2010 c) Appendix II – Historical Trend of UK Unemployment Rate Source: Office for National Statistics (2010 d) Appendix III – Historical Trend in UK’s Balance of Payments Source: Office for National Statistics (2010 e) Appendix IV – Historical Trend of UK Inflation Rate Source: Office for National Statistics (2010 f) Appendix V – Historical Trend of CPI Goods and Services Source: Bank of England (2010) Appendix VI – Decrease in Government Spending Decreases GDP Appendix VII – Decrease in GDP Decreases Employment Opportunity Appendix VIII – Increased GDP Increases Employment Opportunity References Bank of England. (2010, November). 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