Effectiveness of Government and Central Bank Policies - Assignment Example

Macro and Micro Economics Contents Introduction 3 Effectiveness of Government and Central Bank Policies 3 Macroeconomic Performance 6 Conclusion 9 Introduction Since the global financial crisis of 2008, economies of nearly all American and European countries have been severely crippled. The economic growth of majority of Western countries had been highly jilted. This has raised concerns among the countries for restoring their growth trajectory to that of the pre-crisis level. In order to do so, monetary policies of the central bank and fiscal policies of the government have become important factors. One of the primary tasks of the monetary authority is to control expectations of future inflation. This is essential primarily for two reasons. Firstly, by taming expectations, actual inflation can be controlled; and secondly, this will also lead to stability in employment and output. Similarly, purpose of the fiscal policy (whereby the government alters public expenditure and taxation policies) is to boost aggregate demand of the country, which in turn is expected to improve growth rate of the economy (Lawton, 2013). The purpose of this paper is to discuss performance of Germany over the last two years, in terms of effectiveness of the government and central bank policies as well as macroeconomic variables. Effectiveness of Government and Central Bank Policies In the wake of the global financial crisis, Germany, like most other developed countries, is following the policy of fiscal tightening. Germany is a member of the programs undertaken by Euro Plus Act and main commitment of this program was to reduce debt of the government. High debts of the government are not supportive for the long run as this increases the risk of default. Polices of the government are being heavily guided by withdrawal of stimulus and measures of consolidation coupled with reduction of social security benefits. Fiscal consolidation measures followed by German government have been effective in bringing down both the structural and actual deficit of the country. The deficit of the government was brought down below the reference figure of 3%. The general finances of government had also shown a surplus in 2012 for the first time, after the crisis. This makes it clear that the country has been successful in achieving the medium-term budgetary goal and structural deficit is within 0.5% of GDP. Bringing down structural deficit is also important for controlling long-term stability of a country; and in case of Germany, it has been observed that in 2012, the structural net borrowing was only 0.31% of GDP, which was well within control of the government. Even in 2013, structural deficit was below the stipulated value of 0.35% (Deutsche Bank, 2013). On expenditure side of the fiscal policy, main focus of the government in the last two years has been to increase investment in research and developmental programs and education. The rationale behind doing this is to stimulate long-term growth drivers. In 2012, the government had invested almost 13 billion Euros in these sectors. Despite bleak global economic conditions, the government is investing in infrastructural projects. The business taxation laws have also been amended in 2013 so as to enhance competitiveness and economic growth. Fiscal policies are extremely important for boosting aggregate demand of the country. It has been observed that Germany had reduced the proportion of the government revenue; major part of this is directed to reduce the structural deficit and a smaller section of it contributes towards boosting critical areas of public sector, namely education and health. Therefore, it can be implied that the government is following a fiscal contrationary policy as a part of austerity measures to reduce debt. It was observed that in 2012, Germany was under a tax burden imposed by fiscal drag. In 2013, the country was committed to reform the rates of income tax. The government had also been taking measures to better financial supervision and activate Financial Market Stabilization Fund for protecting the market from any future financial stress (Lawton, 2013). Deutsche Bank is the central bank of Germany, which shapes the monetary policy. The European Central bank that has the entire jurisdiction of the Euro zone area is influenced to a large extent by the central bank of Germany in formulating monetary policy for the entire Euro zone. Since the financial crisis of 2007 and particularly in 2010, the rift between these two banks widened to a great extent, owing to difference in opinions regarding pressing matters. In the last two years, Germany has been following expansionary monetary policy. It has been observed that yields on the short-term bonds have improved in 2013, after being negative for most of the second half of 2012 (Council on Foreign Relations, 2014). The primary objective of ECB during the last two years has been to maintain stability in prices, during times of economic distress. The monetary policy undertaken by the bank has been quite successful in maintaining fluctuations of consumer price index within control. The policies undertaken by the central bank are expected to boost private consumption of the economy. The bank has managed to keep the rates of interest low for last two years. This coupled with low rates of unemployment, rising levels of employment and rising real wages have enhanced private consumption of the economy. The construction industry of the economy had also been boosted due to policies stated by bank. In one of the shocking developments in November, the bank had lowered the interest rate charged from the commercial banks to 0.25%. This came at a time when inflation in the country was running as low as 0.7%. This had raised concerns among economists as very low inflation is equally harmful for the economy as GDP tends to stall. The rationale behind doing this was to increase the number of loans taken by investors and households to boost the economy. Despite low levels of inflation, the Central Bank was sure that growth trajectory of the economy will be unaltered. Germany had, however, not supported the Quantitative Easing adopted by ECB as it believed that the policy will not be sustainable in the long run (International Monetary Fund, 2013). Therefore, it can be seen that policies that had been adopted by Central Bank and the government has been quite successful in maintaining growth rates of Germany. Germany has been considered as one of the leading drivers of growth for the entire European Union. Macroeconomic Performance The macroeconomic performance of a country can be judged in terms of the number of macroeconomic variables. The few variables that are involved in this study includes GDP growth rate over the last two years, level of unemployment, rate of inflation and trade volume of the country. Output: The GDP of an economy is often taken as a proxy to understand the level of output produced in a country. One of the basic purposes of the government policies is to increase the level of output produced in an economy. The overall economic health of a country is judged in terms of growth of GDP. For Germany, it has been observed that the level of GDP has expanded in 2013 than that in 2012. Compared to the last quarter of 2012, GDP had expanded by 1.30%; whereas, compared to the value of 2011, this figure has definitely lowered as in the first quarter of 2011; GDP growth of Germany had reached a record high of 5.20%. This implies that even during difficult economic times, Germany had continued to maintain positive growth and that too at a rate higher than other countries of the European Union. Owing to policies of the government, GDP of the country had shown continuous expansion, but intensity of this growth had fallen (Federal Ministry of Finance, 2013). Unemployment: High rates of prolonged unemployment are detrimental to overall growth of the economy, owing to fall in output. Germany is one of the countries of European Union, which has achieved one of the best results in mitigating unemployment compared to other countries of European Union. The following graph shows the level of unemployment that has been recorded in Germany from 2011 to 2013. Figure 1: Unemployment trend (Source: Trading Economics, 2014a) It can be clearly seen from the graph that the level of unemployment has followed a downward trend for Germany over the last two years. In fact, when compared to unemployment levels of the pre-recession period; it has been found that this level has reduced. This reflects effectiveness of the monetary policy. Other developed countries have been learning to tackle unemployment problem from Germany. Owing to policies undertaken by the government and monetary policy of the Central bank, the average number of unemployed in Germany was found to be 2.9 million in 2012; a loss of 80000 compared to the previous year. Though robustness of employment growth has reduced, yet in 2012, the number of employed had risen by 449000 (Federal Ministry of Finance, 2013). Inflation: Taming inflation is the most significant aspect of monetary policy as high rates of inflation causes instability in output and employment. The problem becomes complex because of the inverse relationship between inflation and unemployment. The inverse relationship between the two is captured by the Philips curve. There is a tendency of the policy makers to stimulate economic growth in the short run by increasing level of inflation in the long run. In Germany, it has been observed that main driver of inflation was the rise in prices of energy products. The following graph shows the rates of inflation in Germany from 2011 to 2013. Figure 2: Inflation figures (Source: Trading Economics, 2014b) The rates of inflation in Germany have mainly ranged from 1.15 to 2.16 percent, which is fairly stable. The main reason of fluctuation of inflation rates in 2013 was higher food and fuel prices at that point. The massive flood in Euro zone had devastated agricultural produce, which had fanned the inflation. According to the forecasts of Deutsche Bank, consumer price index is expected to grow by 1.4% in 2013 compared to the previous year growth of 2% (Reserve Bank, 2013). Trade Balance: Performance of country in terms of trade balance depends on conditions of other trading partners as well. It has been observed that after the global economic downturn, most countries of the European Union had been severely affected. As a result, trading performance of Germany had also been under pressure. Net exports had been one of the key reasons of growth for the country in 2012. Nonetheless, most of the demand for exports had stemmed from countries outside the European Union. Real exports had grown, but pace of growth was lower compared to 2011 (Elwell, 2013). The investment in physical capital made by the country during this time period had also shown signs of weakness compared to 2011. As a result of weak performance of the export sector and declining investment, imports of the country had also fallen during last two years. The country had recorded consistent trade surplus over the two years under study. The exports sector is strongly driven by the automobile sector, hardware equipments and chemical products. Conclusion This essay has highlighted policies adopted by the government and the central bank in the previous two years. On analysis of the given data and facts, it appears that the government of the country has been quite successful in running the economy. This is because compared to the other countries of the European Union; Germany has shown one of the most robust performances, in terms of major macroeconomic variables. In terms of growth of output that is measured through GDP, performance of the country is quite promising. Though intensity of growth has fallen in 2013 compared to 2011, yet the government manages to post positive growth rates, when countries like, Italy, are recording negative growth. In terms of unemployment and inflation too, the country has shown promising performance. The level of employment has grown and the unemployment figure shows consistent fall. Yet, it can be said in case of unemployment that in comparison to 2011, the figures in 2012 and 2013 are marginally weaker. Finally, trade balance of the country has recorded surplus in both the years under study. The weaker conditions of other economies of the Euro zone have impacted performance of Germany to some extent. Reference List Council on Foreign Relations, 2014. Germanys central bank and the Eurozone. [online] Available at: [Accessed 21 March 2014]. Deutsche Bank, 2013. Focus Germany the brave new world of monetary policy. [pdf] Deutsche Bank. Available at: [Accessed 21 March 2014]. Federal Ministry of Finance, 2013. German stability programme. [pdf] Federal Ministry of Finance. Available at: < http://ec.europa.eu/europe2020/pdf/nd/sp2013_germany_en.pdf> [Accessed 21 March 2014]. International Monetary Fund, 2013. Germany: 2013 Article IV Consultation. Washington: International Monetary Fund. Lawton, C., 2013. German central bank raises growth forecast. [online] Available at: [Accessed 21 March 2014]. Reserve Bank, 2013. Statement on monetary policy. [pdf] Statement on monetary policy. Available at: 3 [Accessed 21 March 2014]. Trading Economics, 2014a. Germany Unemployment Rate. [online] Available at: [Accessed 21 March 2014]. Trading Economics, 2014b. Germany Inflation Rate. [online] Available at: [Accessed 21 March 2014]. Read More