Macroeconomic Policies - Assignment Example

Question Macroeconomics is mostly focused upon the achievement of growth targets, containing inflation as well as ensuring that unemployment level remain within acceptable limit. (Mankiw, 2003). All macroeconomic policies therefore revolve around the achievement of above objectives no matter what types of macroeconomic policies are adapted. The recent economic performance of UK indicates that despite the recessionary pressures on the economy, it is showing slow recovery. (Pimlott, 2010) The policies used by the current government therefore are showing the results and contributing towards the achievement of larger goals of achieving sustainable level of economic growth. Some of the recent steps taken by the current government include some very drastic changes in the government spending and increases in taxes. This is being done in the wake of the higher level of government debt which is even greater than GDP of the country. Before the austerity measures there were discussions that UK might default on its commitments owing to large amount of public debt which were undertaken by previous government as a part of its fiscal expansion efforts to stimulate the economy. In order to discuss whether the steps taken by British Government were successful in achieving the desired objectives, it is important to understand that from Nov 2008 till now, two governments were running the affairs of State. Current Conservative Government took charge in 2009 so before that labour government was running the show and adapted policies which were radically different from what is now being practiced and preached under the David Cameron’s new conservative government. Economic Growth during the period Last two quarters of 2008 witnessed continuous drop in GDP of the country and during the last quarter i.e. September to December 2008, UK officially entered into the recession. Recession is often characterize by the decline in the gross domestic product of the country for more than one quarter therefore during the initial period, UK economy experienced decline in growth and policies adapted by than labor government were not successful in generating the desired results. The above graph1 shows the GDP growth trends for last five years i.e. since 2005 till third quarter of current year. These trends indicate that UK’s economy started to pick up from the second quarter of 2009 indicating that the efforts taken by the British Government were successful in initiating the process of recovery in economy. What is also important to note that there is a debate going on suggesting that the real impact of the austerity measures will start to manifest later and there are chances that UK economy will contract due to the measures currently taken by the David Cameron. Economists like Stieglitz are projecting a very different picture of future for UK owing to the current steps taken by UK government. Inflation The CPI trends in the above graph2 are suggesting that the inflation has probably started to rise from third quarter of 2009. The rise in inflation is owing to the fact that Bank of England has kept the interest rates at relatively low levels in order to ensure that consumer lending is easier. This is also done in order to ensure that the consumer spending remains at acceptable levels in order to increase the aggregate demand for goods and services. Unemployment and Balance of Trade The unemployment level in the economy is decreasing as during the current year, employment level improved by 0.4% however, most of this improvement has been made owing to the fact that people have started to work part time. Data therefore suggest that there is actually a drop in the full time employment and the level of unemployment has only decreased due to increase in part time employment. Source: Office for National Statistics3 Data also indicate that the country’s trade balance has improved due to the improvement in trade balance in services. UK has been able to export more services than it imported during the period under study thus registering a trade surplus in services. However, economy faced trade deficit in goods suggesting that the UK has remained net importer of goods despite the recessionary phase through which it was going through. Trade Balance Trends- Source: Office for National Statistics4 The discussion provided above indicates that the economic recovery of the country is probably slow and the policies adapted by the government have been successful in starting the process of recovery in the economy. Trends during this period indicate that things will start getting better for the economy however, not all the macroeconomic variables are showing favorable trends. Thus it can be concluded that the policies adapted by the British Government were partly successful in achieving the desired results. Q#2 Macroeconomic policies are always directed at achieving the growth and distribution targets besides ensuring that they also provide sustainability to the economy. As such any macroeconomic policy is aimed at achieving high growth rates, low levels of unemployment and inflation. Based on these broader themes, there are two types of policies which are adapted i.e. demand side and supply side policies. If an economy adapts supply side policies, it basically allow the markets to take their own course of action and there is very little or no intervention from the government. However, on the demand side policies, government may play active part in managing the economy through fiscal intervention. The differences between the two policy options exercised therefore are based upon the role of government in managing the economy and what course of action is taken under both the strands of macroeconomic policies. Further discussion on the what policies have been adapted by the British government from November 2008 to November 2010 therefore need to be discussed from this perspective Policies from Nov 2008 till New Elections in 2009 Britain experienced the financial crisis under the government of labor and most of the initial response towards the crisis came under their government. Labor government, till last elections, followed the expansionary fiscal policy which comes under the demand side macroeconomic policies. Fiscal expansionary policy was adapted in order to stimulate the aggregate demand in the country as well as to ensure that government provide continues support to the economy. In November 2008, Aliaster Darling announced important fiscal expansion measures including the reduction in the VAT as well as the unveiling of plan to built new counsel housing units. (BBC, 2009). VAT was reduced in order to ensure that the prices remain low and that the consumers keep on spending in order to generate the demand for goods and services. The housing units were planned to be built for providing alternative homes to the people whose homes were repossessed due to the credit crunch and subprime mortgage crisis. It is also important to note that the labor government also unveiled the plans for increasing the taxes for the higher income earning group of the society therefore actually ensuring that the high income earning group of the society. Policies adapted by Bank of England during the labor government were mostly based upon the expansionary monetary policy wherein the interest rates were kept low as well as the money supply was increased through different measures such as quantitative easing. Expansionary monetary policy also allowed the government to ensure that consumer spending does not drop beyond a certain level. Expansionary monetary and fiscal policies are mostly demand side policies wherein the government tends to intervene into the affairs of the market and help it to adjust towards the equilibrium level. However, due to expansionary monetary policy, inflationary pressures on the economy tend to be higher because interest rates are reduced to a level where borrowing becomes easier and the consumer can get access to the cheap money.(Abel & Bernanke, 2004). Adaptation of expansionary fiscal policy however, can result into the budget deficits and higher government debt. Budget deficit arises when the government expenditures are higher than the revenues it is earning therefore in order to fill that short fall, government has to borrow. It was exactly due to this reason that the government debt during Gordon Brown’s government increased manifolds. The above graph shows the UK Government’s budget deficit as a percentage of GDP5 indicating a sharp rise in the budget deficit. During the year 2009/2010, the overall budget deficit of UK crossed 11% limit which is much higher than the limit set for the EU countries under Maastricht Treaty. The above discussion therefore indicates that though the expansionary fiscal and monetary policies were adapted under the Labour government, however, due to these policies the overall budget deficit increased and the government debt also increased to a greater level. Due to expansionary fiscal policies, crowding out effect also occurs which reduces the available debt to the private sector. Since under expansionary fiscal policy, government spends and borrow therefore the availability of debt for private sector reduces thus it can put pressure on the interest rates to rise. However, government kept the interest rates at lower levels deliberately. Policies under Conservative Government Conservative government adapted mix of both the policies as on one hand, it attempted to reduce the government debt but also allowed market to work on its own. New government adapted a fiscal policy which is contactionary in nature as government announced drastic measures to reduce the government spending, cut the number of jobs, increased the taxes, raised the University fees besides taking other strict measures to reduce the government debt and budget deficit.(Inman, 2010). Under contractionary fiscal policy, government spending is reduced, taxes are increased and the overall transfer payments are decreased too in order to close the inflationary gap. The overall goal basically is to reduce the inflationary pressures on the economy in the anticipation that the economy may grow at the expense of high inflation. This is exactly what is currently happening in UK as due to keeping the interest rates are lower levels for long period of time, inflation has continued to increase. Further, the contractionary fiscal policy adapted by the current government is also aimed at reducing the government debt which has increased to a great length. It has been anticipated that at such higher level of government debt, there were chances that the UK may default on its commitments. It is also important to note that Bank of England has continued to adapt an expansionary monetary policy wherein the interest rates are kept at low levels whereas the money supply is kept at higher levels through the methods such as quantitative easing. Expansionary monetary policy stance is adapted in order to ensure that the money supply remain at the adequate level therefore in times when government purchases are reduced, economy can be stabilized through the expansionary monetary policy to achieve the growth objectives. As discussed in the first question, the policies adapted by the current government seem to pay dividend as GDP of the country has started to rise and so does the drop in the unemployment levels. Forecasts are that the economy will grow in 2011 also thus indicating that the demand side policies adapted by the current UK government tend to provide results and may further stabilize the economy. It is also critical to note that there is a strong debate going on suggesting that the current measures taken by the Conservative government may further create problems for the economy. Economists like Joseph Stieglitz are not endorsing the current economic policies of the government and fear that the reduction in government spending in such recessionary periods may further create problems in the future and reduce the GDP of the country in coming periods.(Dunkley, 2010). It is also important to note that the current policies are also indicating that the government may be slowly allowing the supply side policies to come into effect too. By reducing the government intervention from the market, government may be allowing the markets to evolve on their own and readjust itself to bring the equilibrium in the market. On whole, government policies are bringing results for the economy. References 1. Abel, A, Bernanke, B (2000). Macroeconomics. 4th. ed. New York: Addison Wesley. 2. Darling unveils borrowing gamble [online]. (2009) [Accessed 10th November 2010]. Available from: . 3. Dunkley, J (2010). Austerity cutbacks are an economic disaster, Nobel Prize winner Joseph Stiglitz warns [online]. [Accessed 10th November 2010]. Available from: . 4. Inman, P (2010). Budget 2010: Plans to turn record debt into surplus cheers City [online]. [Accessed 10th Nove 2010]. Available from: . 5. Mankiw, G (2003). Macroeconomics. 5th. ed. New York: Worth Publishers. 6. Pimlott, D (2010). Small steps on path towards growth [online]. [Accessed 9th November 2010]. Available from: . 7. UK close to leaving recession [online]. (2010) [Accessed 10th November 2010]. Available from: . Read More