Has the Government and the Bank of England Been Successful in Running British Economy - Case Study Example

Has the Government and the Bank of England been Successful in Running British Economy Over the Last Two Years? Subject / Course Date Introduction The United Kingdom is considered as a very successful state capitalist economy. Since the United Kingdom is the 5th largest in the world market in terms of its exchange rate and the 3rd in terms of its purchasing power parity (PPP) (Finfacts Team, 2007)i, the country is considered as one of the most advanced and developed country around the world. (See Appendix I – World Shares of GDP on page 9) Despite the strength of the British economy, the International Monetary Fund (IMF) has recently warned the public of the possibility that the overall economic condition in UK can be negatively affected because of the global financial crisis combined with the continuously increasing commodity prices (Tang, 2008)ii. The fact that many of the UK private banking sector has been negatively affected by the U.S. economic crisis (FT.com, 2008)iii, the entire British economy is likely to suffer the consequences. To determine whether or not he British government and the Bank of England has been successful in running the British economy, evidences pertaining to the degree wherein the British government and the Bank of England failed to run the British economy successfully will be identified and thoroughly discussed. As part of the main discussion, the employment and unemployment rate, gross domestic product (GDP), and budget deficit during the past two years will be analysed to determine whether or not the British government was able to successfully manage the British economy. Eventually, the effectiveness of the fiscal policy used by the government in terms of addressing the recent problems of the British economy will be criticized. Likewise, the success of the Bank of England in terms of running the British economy will also be tackled in this study. As part of discussing this subject matter, exchange rate and inflation rate during the past two years will be identified and analyzed to determine whether or not the Bank of England has been successful in managing the British economy followed by discussing the monetary policy that is being currently used to address problems related to the recent British economic condition. As part of the conclusion, whether or not the British government and the Bank of England has been successful in running the British economy will be answered followed by providing some recommended solutions that can improve the British economy despite the global financial crisis many countries are facing today. Employment and Unemployment Rate, Gross Domestic Product (GDP), and Budget Deficit during the Past Two Years According to Tang (2008), macroeconomic weaknesses in the British economy has becoming evident even before the recent global shocks was announced. This is primarily because of the fact that the domestic demand and supply for goods and services was significantly increasing more than the expected economic growth (Tang, 2008)iv. Considering the current economic situation in UK, the main reason for the sudden decline in the total household savings is not caused by a significant decline in the household income but a higher investment spending. Down by 122,000 or 0.4% as compared to the previous quarter, only 29.42 million or 74.4% of the working age individuals (ages 16 and above) are employed as of August 2008 (National Statisics Office, 2008). On the other hand, the unemployment rate in the United Kingdom increased up to 5.7% which is 164,000 or 0.5% higher as compared to the previous quarter (National Statisics Office, 2008)v. Based on the explanation made by the National Statistics Office (NSO), the sudden increase in the number of unemployment rate was significantly caused by the large number of young men (111,000 to 1.060 million) and women (52,000) who has recently reached the age of 16 years old (National Statistics Office, 2008b). Even though there has been a significant decline in the employment rate since May 2008 and an increase in the unemployment rate, the inactivity rate on working age group which falls at 20.9% remains the same (National Statistics Office, 2008b).vi (See Appendix IV – UK Employment and Unemployment Rate on page 11) The GDP growth rate in UK has always been positive. For the first time during the past five years, the overall GDP growth during the 3rd quarter of 2008 was – 0.5% (National Statistics Office, 2008c)vii. This economic indicator shows that the British economy has been significantly affected by the global shock caused by the slow economic growth in the United States. As a result of the global economic crisis, the production output of major industries related to manufacturing, transportation, storage, and communication, construction, mining and quarrying including the electricity, gas, and water output among others decreases between 0.1 – 1.0% as compared with the output during the previous quarter (National Statistics Office, 2008c). It means that there is really a significant decline in the demand for products and services which also affects both the country’s employment and unemployment rate. (See Appendix V – Decline in UK GDP Growth during the Third Quarter of 2008 on page 12) There is also an alarming sign with regards to the government deficits. Between the years 2003 to 2007, the British government deficit has been significantly increasing from –1.3% of GDP back in 2003 up to -4.2% of GDP in 2007 (Tang, 2008). This is a good economic sign that the British government has been very much relying on borrowing money outside the country. Given that the British government would eventually fail to have a strong control the budget deficit, there is a possibility for the British economy to experience the same negative economic consequences that is currently being experienced by the United States today. (See Appendix II – Growing Imbalances: The External Current Account and Fiscal Balance were Weakening before the Recent Global Shocks on page 10) Effectiveness of the Fiscal Policy used by the Government in terms of Addressing the Recent Problems of the British Economy Part of the government’s strategy in addressing the economic down turn is to increase the amount of borrowings until the collection of tax revenues recover. (Mulholland, 2008)viii With regards to the increasing amount of government deficit, Gordon Brown insisted that his fiscal policy of “borrowing money from outside sources was the right thing to do to support the spending during the economic downturn” despite the oppositions with regards to his proposed fiscal policy (Echo.co.uk, 2008)ix. Personally, I strongly agree that borrowing money can help generate new job opportunity for the local people. However, there is a limitation with the use of such economic theory. In general, increasing the amount of borrowings during a serious global economic crisis is not the best option to take since this particular fiscal strategy can only lead long-term serious economic problems. Basically, the use of borrowed money during a global economic crisis is a temporary solution since increasing the amount of government deficit does not address the main cause of economic problem. Exchange Rate and Inflation Rate during the Past Two Years As of 2007, the exchange rate of British pounds per US dollar at 0.4993 is much higher as compared with 0.5418 the previous year (Central Intelligence Agency, 2008). It means that the country’s exchange rate has strengthened over the US dollar making them able to purchase more goods when purchasing goods and services outside the country. The problem with having a strong currency is associated with the fact that major export groups that are based in UK will have a difficult time selling their products and services outside the country. Given that UK exchange rate has strengthened as compared to the past two years, competitive edge of export businesses throughout the United Kingdom against other exporters around the global markets decreases. (See Appendix III – Exchange Rate: British pounders per US Dollar on page 10) The government’s target inflation rate should be as low as 2%. (BBC News, 2008) Caused by the high prices of crude oil in the world market, inflation rate in UK reached an 11-year high of 3% back in December 2006 (BBC, 2007)x. Today, inflation rate in UK reached as high as 16-year high of 5.2% (BBC News, 2008)xi. The problem with having a significantly high inflation rate is the fact that the market prices of local goods and other commodities would also increase. When this happen, there is a strong possibility for the British economy to experience ‘overheating’. Monetary Policy that is being Currently Use in Addressing Problems related to the Recent British Economic Condition Back in 2006, the interest rate as dictated by the Bank of England was as high as 5.25% (BBC, 2007). Given the fact that UK inflation rate has reached 5.2%, Bank of England decided to cut down the interest rate from 5% to 4.5% (BBC News, 2008). Basically, decreasing the interest rate may not encourage people to save their money in banks. Instead of saving money in the local banks, lowering the interest rate could only encourage more people to borrow money from banks for some investment purposes. This monetary policy is good in terms of encouraging people to establish and operate small-scale businesses which could promote healthy domestic market environment. Conclusion The major economic challenges being faced by the British economy is not only related with a very high inflation rate but also a significantly high government deficit. There is a saying that “history repeats itself”. With regards to this statement, we have seen that the U.S. government has depended too much on borrowing money from outside sources. Today, we are experiencing the long-term consequences of U.S.’s excessive government deficit. For this reason, I conclude that the British government’s fiscal policy is not good in terms of successfully running the British economy. Instead of borrowing excessively large sum of money from external sources, monetary policy such as lowering the interest rate is more effective in terms of addressing the existing economic problem in UK. By lowering the interest rate, more people would be encouraged to borrow money from the banks to invest on small- and medium-scale businesses. Given that a larger number of small- and medium-scale businesses would participate in the overall British economic activities, tight competition among the new and existing businesses would increase causing the business people to experience price war. Combined with government regulation of the prices of commodities, it is possible for UK government to lower down the inflation rate without the need to borrow large amount of money overseas. *** End *** Appendix I – World Shares of GDP Share of Global GDP (%) Gross Domestic Product (GDP) PPP-Based Market Exchange Rate United States 23 28 China 10 5 Japan 7 10 Germany 5 6 India 4 2 United Kingdom 3 5 France 3 5 Russian Federation 3 2 Italy 3 4 Brazil 3 2 Spain 2 3 Mexico 2 2 Source: World Bank study says 12 economies account for more than two-thirds of worlds output; Chinese economy size cut by 40%; Ireland is fourth most expensive world economy, 2007 Appendix II – Growing Imbalances: The External Current Account and Fiscal Balance were Weakening before the Recent Global Shocks Source: Twin Global Shocks Dent United Kingdom Outlook, 2008 Appendix III – Exchange Rate: British pounders per US Dollar 2007 2006 2005 2004 2003 0.4993 0.5418 0.5493 0.5462 0.6125 Source: Central Intelligence Agency, 2008 Appendix IV – UK Employment and Unemployment Rate Source: National Statistics Office, 2008 Employment Rate in UK Source: National Statistics Office, 2008b Appendix V – Decline in UK GDP Growth during the Third Quarter of 2008 Source: National Statistics Office, 2008c Annotated Bibliography Read More