Fiscal Responses to the Global Financial Crisis in the UK - Essay Example

The fiscal strategy of the UK Conservative-Liberal Democrat Coalition government Introduction After the U.K. general election, which happened in May 2010, a hung Parliament was realized and this led to the formation of the Conservative–Liberal Democrat coalition. Britain has long history devastating coalitions. However, after World War 2, party politics in the UK became extremely polarized and therefore the 2010 results were a novelty. The Conservative–Liberal Democrat coalition has had its fair share of challenges, especially pertaining to the fiscal strategies. This is because the Conservative–Liberal Democrat coalition has made little or no progress in dealing with the bud¬get insufficiency and the country’s underlying economic flaws. There is no plausible, consistent, or convincing measure that has been established to oversee national recovery by the coalition government. As a corollary, this paper will endeavour to critically appraise the fiscal strategy of the UK Conservative-Liberal Democrat Coalition government. To come up with a comprehensive and detailed appraisal, it is essential to revisit the genesis of the current financial woes in the UK and the rest of the world i.e. the global financial crisis. The global financial crisis in relation to the fiscal strategy of the UK Conservative-Liberal Democrat Coalition government The first indicators of the global financial crisis were realized on August 2007. They developed progressively throughout the 2008. It was not until September/October 2008, that the full-blown effects of the crisis were realized. In this document, a succinct summary of the fiscal policy response strategies to the global financial crisis in the UK is given. An emphasis is given to the changes in those strategies after the shift of power from the Labour government to the Conservative-Liberal Democrat coalition. The Conservative-Liberal Democrat coalition took fiscal austerity stance in a bid to counter the financial woes in the UK. This was particularly evident in the emergency budget was produced months after the inauguration of the Conservative-Liberal Democrat coalition where public expenditure cut were projected and the declaration of a programme to eradicate the structural budget discrepancies for five years was made. Fiscal responses to the global financial crisis in the UK In March 2008, the Treasury asserted that UK’s the economy was unwavering and flexible, was experiencing a steady growth, and that the country had the aptitude to deal with fiscal shocks swiftly and with minimum financial expenses (HM Treasury, 2008a: 2). This self-satisfied stance changed in September/October 2008 when major financial effects of the global crisis started being experienced. The Labour government established a strategy aimed at enhancing the episodically adjusted budget each year, so as to ensure that, the borrowing rate in every financial year from 2011 to 2016 would be less than it was in the previous financial year. (HM Treasury, 2008b: 13). The Budget by Conservative-Liberal Democrat coalition in March 2010, made several modifications to the fiscal strategies that had been previously laid by The Labour government. The coalition government proposed to alleviate the structural budget discrepancies in a period of five years. The fiscal strategies proposed by the coalition government seemed committed to extensively hasten the reduction of the structural budget discrepancy by reducing expenditure instead of increasing taxes. This fiscal strategy of taking austerity measures was explicated in an emergency budget in June 2010 (Cabinet Office, 2010: 15). How the coalition government justifies its austerity strategy The discretionary austerity fiscal strategy as propesed by the Coalition government is intended to attain a 60% reduction in public expenditure by 2014/15, which is 20% more than the intended figure in the Labour government’s fiscal strategy. The Treasury asserted that austerity fiscal strategy is in agreement with OECD and IMF study, which staes that economic consolidation endeavours that fundamentally are dependent on expenditure moderation encourage intensification of the countries economy (OECD, 2011: 228). However is important to note that tax based strategies can be also be effective in the swift reduction of budgetary deficit allowing for phased reductions in public spending. Drawing reference form this, the coalition government’s consolidation strategies is dependent on the public expenditure during its forecast time of existence (HM Treasury, 2011, p. 15) Appraisal of the austerity strategy by the Conservative-Liberal Democrat Coalition government Arguments opposed to the notion that there is a need for fiscal strategies and control of budget discrepancy fundamentally depends on the assertion that that the private sector is self-correcting. This assertion is based on Says’ Law, which affirms that demand gradually comes into balance with supply. The assertion also draws reference from the Ricardian equivalence theorem, which states that the presence of fully rational agents can enable public expenditure to displace private spending patterns thus leaving the general level of demand unaffected. Direct application of the latter assertion is hard to sustain particularly because its assumptions about rational expectations and credit rationing are deeply flawed. While there has been little, if any, application to the above assertions in the Coalition government’ fiscal strategy, in a way the strategy is dependent on resurgence in private. After probing on the concept, it became evident that indeed, the Coalition government is hinging its endeavors on the resurgence of private demand. However, the clarity on how much the coalition government relies on the resurgence is yet to be established. Nevertheless, according to the Office for Budget Responsibility (OBR, 2011) the reductions in the structural budgetary discrepancies are accompanied by an augmentation in private spending. The argument that austerity measures impose a burden on future generations has frequently been made. For example, HM Treasury, (2010b: 11) stipulated that public borrowing is deferred taxation, and it is reckless and iniquitous to amass large debts in a bid to finance expenditure that merits the current generation at the expense of successive generations. However, this assertion is, perceptibly, spurious. This is because interest payments on the debt involve exchanges between taxpayers and bondholders in the same timeline. The burden on the current generation of a balanced financial plan during recession would be the foregone spending and public services, which come from a budgetary discrepancy. On the other hand, the burden on successive generations of a balanced budget during recession would be foregone investment, which would lead to future benefits. Investment in this context can be construed any endeavour aimed at reviving the infrastructure, education and health of the country. Another argument used against the coalition government’s austerity strategy is that it is unsustainable because continued borrowing brings about ever-rising debt. HM Treasury (2011: 34) affirmed that dealing with the budgetary discrepancy would make sure that future generations are not weighed down by unsustainable debt and will strengthen the private sector’s buoyancy, thus leading to growth and employment creation over the medium term. When considering the application of austerity measures, it is imperative that the difference between the rate of interest and the rate of development. Empirically, a scenario where the rates are approximately equal seems to be more prevalent. For example, in a report about financing university education as well as student loans, an interest rate on loans of 2.2% was suggested equal to the Government’s borrowing rates (Browne 6 Report, 2010, p. 35). According to the report, this would be just a little below the expansion rate of the UK’s economy, thus; this would put the primary budget in balance and deficit equal to interest payments. I.e. borrowing would cater for the interest rates. The Coalition government and its supporters usually argue the austerity strategy is deemed the most realistic for the financial markets. This is because a strategy like this, there would be significantly huge interest rates on government borrowing and considerable difficulties in efforts to balance the economy. This argument is usually articulated in terms of the reactions of the credit ratings organizations and fears of relegation of a government’s credit rating, which would lead to huge interest rates. This has been underpinned by referring to countries whose credit rating has been decreased (e.g. Greece) Greece is an example of what ensues when the government of a country lacks the enthusiasm to take action resolutely and swiftly, and what happens when problems are taken lightly without coming up without a solution. The outcome is an extreme rise in interest rates, aggravation of recession, increasing unemployment. In Greece, the situation became so serious that the interest rates rose by 10%. As a result, Osborne, (2010) cautions that if the UK government fails to deal with the deficit inherited from the Labour Government, the ramifications could be devastating. Expansion of spending calls for an increase in financial support, and that means that credit constrictions do not thwart investment and an increase in foreign trade. To completely explicate this issue, it is important to the most appropriate policy reaction in case of a credit rating downgrade. One reaction would be to make sure that the Bank of England is prepared to purchase government debt as necessary. Another reaction would be to put laws in place that oblige pension funds and life assurance corporations to place a certain percentage of their asset portfolio into government stocks. Drawing reference form these assertions, it is evident that there people put in place to justify for fiscal austerity strategy are yet to come up with a comprehensive appraisal of the strategy Potential output An evaluation of the UK’s finances would reveal that the country’s potential output has been significantly reduced since 2007. The major recession brought about an extensive increase in the budget insufficiency because the revenues collected from taxes fell sharply. This increase in the budget insufficiency can only be reversed if the country’s economy completely recovers from recession, and output reinstated to its normal level. The impact of recession and the global financial crisis on potential output is an example of path reliance and the long-term effects of the path of cumulative demand on supply potential. The conventional approach to macroeconomic evaluation and macroeconomic principles has been steadfastly founded on concepts of ordinary rates (of joblessness, interest rate, and development) where the term ‘ordinary’ is ‘to try to separate the real forces from financial forces. The role of fiscal austerity strategy that was established by the Conservative-Liberal Democrat coalition is to support the establishment and operation of automatic stabilisers and then to reverse the discretionary policies as the financial system gets better A projected decline in potential output brings about a recalibration of the budget insufficiency where it starts being viewed from a cyclical perspective as well as the structural perspective. These perspectives bring about two inferences. First, there is need to make use of fiscal strategies to deal with the drop in demand and financial activity. Second, the gradual decrease in public spending would also lead to a decrease in potential output. In the UK context, this would mean a decline in public spending of the order of 5% (assuming that the public-private split is the pertinent one to be sustained). A variety of validation for fiscal austerity strategies have been evaluated and dismissed by various academics. Sawyer (2011a:2011b) goes through most of these arguments, and concisely articulates that based on the fiscal calculations, there appear to be 3 suggestions that have been made in matters underlying the austerity fiscal stance. (i) That potential output has gone down when compared to previous developments and that potential output is an obstacle that hinders better and sustainable levels of output. (ii) That the recession has led into a decrease in potential output and high levels of demand will not facilitate the reinstatement of potential output. (iii) There will be a remarkable restoration of sustainable investments and net exports and that the levels will be higher than in previous years. In this paper, it is argued that in spite of these suggestions being true, it is important to note that the estimates of potential output are dependent on substantial uncertainty, which should be dealt with in policy formulation. More significantly, it is hard to believe that that potential output (as measured) is an obstacle that hinders better and sustainable levels of output because potential output gives a target, which should be acquired built it does not restrict the economy to that target. Additionally the paper argues that a long-term budget insufficiency is probably necessary so as to attain even measures of potential output. Failure to recognise and consider these assertions may lead to an extended period of insufficient output and substantial levels of joblessness in the country. Conclusion The fundamental principle of ‘functional finance’ is founded on the need for budget insufficiency arise so that they can facilitate high levels of financial activity in the face of private sector discrepancies. The fiscal strategy to be implemented should as a result start the other way round. The impetus of net exports, whether by means of exchange rate adjustments or enhancements in competitiveness can prove successful in one country but obviously cannot be a universal answer. A revitalization of investment, especially when centered on public and green investments, can be of significant help to efforts aimed at minimising the budget insufficiency in the UK. Ultimately, significant shifts in inequality (in a progressive trend) resulting from amendments in the tax structure, provision of societal benefits and in the salary structure (e.g. the establishment of ‘living wage’) can extensively affect expenditure and savings decisions. References Browne 6 Report (2010). An independent review of higher education funding and student finance. Available at www.independent.gov.uk/browne-report. Accessed on April 9, 2014 Cabinet Office (2010). The Coalition: our programme for government available at http://www.cabinetoffice.gov.uk/news/coalition-document accesed on April 9, 2014 HM Treasury (2008a). Stability and opportunity¸ London: The Stationery Office, HC 388 HM Treasury (2008b). Pre Budget Report: Facing Global Challenges, London: The Stationery Office, Cmnd 7484 HM Treasury (2010b). Budget 2010, London: The Stationery Office, HC61 HM Treasury (2010a). Budget 2010: Securing the Recovery, London: The Stationery Office, HC 451 HM Treasury (2011). Budget 2011, London: The Stationery Office, HC836 Office for Budget Responsibility (OBR) (2011). Economic and Fiscal Outlook, March 2011, London: Stationery Office, Cmnd. 8036 OECD (2011). Economic Survey: UK, Paris: OECD Osborne, G. (2010). Speech by the Chancellor of the Exchequer, the Rt Hon George Osborne MP, on the OBR and spending announcements. Available at http://www.hmtreasury.gov.uk/press_02_10.htm accessed on April 9, 2014 Sawyer, M. (2011a). ‘Progressive approaches to budget deficits’, in O. Onaran, T. Niechoj, E. Stockhammer, A. Truger, and T. van Treeck (eds), Stabilising an unequal economy? Public debt, financial regulation, and income distribution, Marburg: Metropolis Verlag Sawyer, M. (2011b). ‘UK fiscal policy after the financial crisis.’ Contributions to Political Economy, vol. 30, pp.13-29 Read More