Economic Crisis - Assignment Example

Economic Crisis Task-1 The current economic crisis faced by developed countries including UK has forced them to take on macroeconomic policies which are relatively different in nature. Mounting public debt and higher fiscal deficits require certain structural changes in the way economies of these countries are being run. UK therefore also went on to make macroeconomic policy changes which reflected the current mood in developed countries. Broader level macroeconomic policy objectives include controlling inflation, increasing employment level while also achieving an increase in the level of output (GDP). However, in order to achieve a sustained level of increase in the aggregate output level, it is important that the government must take efforts which can stabilize the economy. Over the period of time, the overall quantum and level of public debt has increased to a greater length within UK. Higher public debt levels along with extra reliance on credit by the private sector have resulted into significant economic problems for UK as an economy. (BBC.co.uk , 2011) This economic situation of UK therefore required a rebalancing of economy with reconsideration of both the fiscal as well as monetary policies adapted by current government of David Cameron. The changes in the fiscal policies of the government were aimed at improving the public finances in medium term whereas changes brought in within monetary policy framework were aimed to disciplining the financial sector to play an active and positive role for the overall growth of the economy. The overall policy focus is on improving the health of the economy which has weakened in the wake of current economic crisis. Fiscal & Monetary Policy Measures One of the key policy measures was the changes in the overall taxation system within the country wherein government attempted to further rationalize the tax system. The overall aim of this was to further increase the efficiency of the tax system while at the same time achieves the necessary growth in economy by increasing government revenue and reducing the tax burden on the private sector of the country. Government announced a system reduction in the main tax rate while further tax concessions have been given to both large as well as small businesses. This reduction is tax rate may be aimed at improving the profitability of the firms while at the same time allowing them to expand and grow in order to increase the level of investment within the economy. Lower tax rates will result into a price reduction which can invariably reduce inflation while at the same time inducing more consumption from the household sector. This combination therefore can result into an increase in the aggregate output. Further, low tax rates increases the disposable income of household thus increasing their overall purchasing power. This increase in disposable income may lead to higher consumption and ultimately an increase in the output level within the economy. However, these efforts of the government may not be sufficient as the austerity measures taken may create an adverse net impact on the economy. UK government has undertaken important austerity measures to reduce public debt and reduce the burden on the welfare system of the country. Chancellor Osborne has undertaken overall austerity measures of approximately £123 billion in order to reduce the overall burden on public finances. Under the austerity measures, government undertook important cuts in the public finances in order to reduce the structural deficit of government. Various job cuts in public sector institutions, reduction in welfare benefits as well as low fiscal expenditure by the government seems to be some of the important steps taken by the current government. Pay freezes, increase in education fees as well as reduction in welfare benefits while increasing retirement age are some of the policy measures taken by current government. (Aldrik & Monaghan, 2011)  Many however, argue that these measures will result into widespread unemployment as well as suppression of aggregate output level. UK unemployment data also seem to confirm this fear that with the current austerity measures, government is only adding more towards unemployment rather than creating more jobs and helping the economy. (Wolf, 2012) Though, it may be possible that these measures may help government to reduce its budget deficit however, it may lead towards more economic hardships for households. A contractionary fiscal policy may result into low aggregate demand because of low government purchases of goods and services. Further, the reduction in transfer payments may undermine the tax cuts thus virtually decreasing the disposable income of households. This reduction in the household income therefore may further result into a decline in consumption expenditure and the aggregate demand or supply may not increase with the same ratio as the government may expect it to increase. Government has also undertaken some monetary policy changes in order to improve the viability and stability of the financial sector. The current crisis emerged from the financial sector of UK therefore effort was made to improve the resiliency of UK financial system. Bank of England, the central bank of the country, took on expansionary monetary policy and reduced the interest rates. The base rate in the economy was reduced to almost zero in order to induce consumer credit and resultantly increase the aggregate demand within the economy. By reducing the interest rates, Bank of England, actually increased the money supply to induce more consumption to achieve growth targets. Bank of England also made quantitative easing as a policy method to artificially increasing the money supply. Through quantitative easing, Bank of England pumped in more money into the system to not only improve the capital and liquidity base of the banks but also create enough liquidity so that banks can easily lend at lower rates of interest. However, this measure also seems to increase inflation rate in UK as UK inflation rate continuously soured high. The current inflation rate is over 3% which is higher than 2% target limit of inflation which Bank of England has to manage. The higher inflation rate therefore may increase the overall cost for the consumers thus putting more pressures on household consumption within the economy. Task-2 Over the period of time, Pound Sterling, the official currency of UK has weakened against major currencies such as Euro and US Dollar. Many argue that despite the sovereign debt crisis and other issues in EU region, pound should have strengthened against Euro. However, this is not something which is happening despite the fact that EU as a region is going through its worst economic phase. One of the key reasons for weak performance of Pound against Euro is due to the interest rate differences between UK and EU. The base rate offered by EU central bank is 1.25% whereas discount rate in UK is only 0.5%. This differential of 0.75% seems to be one of the reasons as to why Euro is continue to perform better than Pound despite economic problems prevailing in EU zone. It is argued that the Pound has performed low as compared to US dollar mainly due to economic recession in UK. UK economy is relatively worst hit as compared to US and the declining economic performance has resulted into the depreciation of Pound sterling over the period of time. Further, there are interest rate differences between UK and rest of the countries causing Pound to further decline. As discussed above that there are differences between the interest rates in UK and EU region causing more demand for Euro. Similarly, higher interest rates in other parts of the world also seems to generate higher demand for their currency as investors will earn more on interest rate differentials. Quantitative easing is also considered as one of the reasons as to why UK Pound has performed low against other currencies. Through quantitative easing, Bank of England has actually increased the money supply in the economy thus putting more pressure on the interest rates. Higher money supply also tends to increase the tendencies to import because excess reserves are spent on buying from abroad. (Sloman, 2004) Low interest rates prevailing within UK economy may also witness a flight of capital as investors may look for more lucrative avenues. This flight of capital can put further pressure on the pound sterling thus making it relatively hard for Pound to maintain its position in the international market. In order to improve the situation and reduce the pressure on Pound, it is important that the interest rates should be increased to not only reduce the gap between Pound and other major currencies but also reduce the inflationary pressures on domestic economy of UK. It is however, argued that weaker pound may be better for UK economy as it will make its exports cheaper thus increasing its overall GDP. A weaker Sterling can reduce the deficit in balance of payments as the exports of the country become more competitive as compared to the imports. As such, UK can take advantage of weak pound by improving its goods and services output and exporting the same at relatively cheaper and competitive prices as compared to the prices prevailing in international market. Task 3(a) There are mixed opinions about the overall health of UK economy as some argue that the austerity measures taken by the government would result in better fiscal management and would ultimately lead to improved performance. However, it is also argued that the economy may not perform according to the expectations and it may further slow down. Recent economic data indicates that the economy is contracting rather than expanding and UK is sliding towards recession again. Lack of growth in manufacturing sector is further adding towards the woos of the economy and it seems that the economy may not grow in near future. Its estimated that overall GDP increase during 2012 will be approximately 0.7% and growth may further stall during the current year and coming year. Worsening global economic performance as well as sovereign debt crisis in EU seems to be key reasons as to why the economy may not perform according to the expectations. (Allen, 2011) Major EU countries such as Greece, Italy and Spain are facing stronger challenges in terms of maintaining their fiscal deficit and public debt. Since UK trades extensively with EU countries therefore lack of demand and declining economic performance of EU countries may have a direct impact on the economic performance of UK. It is feared that the debt crisis in EU may sustain for longer and economies may variably be affected by this sustained crisis. Crisis in EU seem to not only affect the exports of UK but will also result into a decline in the business investment. Lack of business investment therefore will result into reduction in capital stock thus further slowing down the progress of the economy in short term. Overall depressing scenario within EU region therefore may be one of the key reasons as to why UK economy may not grow during next two years. It is also argued that inflation rate will be higher in coming years and can almost touch 5% in next two years. Such high inflation rate may further discourage consumers to make consumption thus reducing aggregate demand within domestic economy. Lack of domestic demand as well as low exports may relatively create stronger influences on UK economy in near future. The austerity measures taken by the government is also one of the reasons as to why economy may further slow down during next 2 years. As a result of the austerity measures, government has reduced welfare payments thus reducing the overall disposable income of households. Such reduction coupled with higher level of inflation therefore can reduce aggregate demand in future and may result into further decline in growth level. The current figures on the level of unemployment also suggest that there are more 2.65 million people who are jobless. Such higher increase in level of unemployment therefore can create further pressure on the economy and it may not recover with rapid pace as compared to economies like US. Unemployment for younger people may further create strong skill shortages and resultantly may result into further unemployment due to lack of skills. 3(b) In post credit crunch era, many industries such as automobile, manufacturing as well as financial sector have declined in performance. The system decline into the performance of these industries suggests that the overall impact of the crisis may be higher. However, there are also some industries which even thrived during the current crisis and mobile phone industry is one of such industries which shown positive signs during the crisis era too. The chosen industry is mobile phone industry in UK which seems to be expanding due to factors which are uncorrelated with the overall decline of the economy. Major firms such as The Carphone Warehouse, Orange, T-Mobile and other have reported growth while citing the reasons that the overall type of the business model is such that it allows these firm to thrive even under tough economic conditions. The overall pricing structure prevailing within the industry allows consumers to continue to buy new handsets and enjoy the services. The normal fee structure in this industry indicates that mostly customers are locked for period up to 18 months thus virtually ensuring for the mobile phone services firms to continue to receive a constant flow of funds despite low economic performance of other sectors in the economy. Constant innovation is another important factor which has allowed the firms to actually continue to look for ways to know how to best satisfy the needs of the customers. By continuously focusing on what customers want and upgrading the technology, mobile phone services firms have been able to retain and increase their customer base. Generally also, there is a boom at international level in this market where service providers as well as handset manufacturers are making good economic progress. Apple Inc, Samsung as well as Nokia are progressing at really greater speed and same momentum seems to be carried by the UK mobile phone industry too. The dramatic change in the way technology has improved has also paved the way for new wave of economic rise in mobile phone industry in UK. As a result of this progress, this industry is also now one of the largest taxpayers in UK. Pricing approach in the industry is such that through contractual arrangements companies lock-in customers, therefore customers have relatively no chance to shift or change plans. Further, new handsets are being rolled out thus keeping the overall interest of customers intact while also attracting new customers. This has made this industry relatively stable industry in terms of total number of subscribers and repeat customers. (Telecomsmarketresearch.com , 2011) Though the current economic performance of the country may not seem good however, the performance of this sector is really impressing. With the way new changes are being brought through technology, there are chances that the sector will grow despite low economic performance. It can be easily concluded that if technological advances continue to take place at same rate, this industry will further grow even under difficult economic situation. As the situation improves, the industry may further grow and expand in coming years. References Aldrik, Philip & Monaghan, Angela (2011) British household incomes hit by austerity measures - Telegraph. [Online] Available at: http://www.telegraph.co.uk/finance/financialcrisis/8964498/British-household-incomes-hit-by-austerity-measures.html [Accessed: 13 Mar 2012]. Allen, Katie (2011) UK economy likely to stall next year in wake of eurozone crisis. [Online] Available at: http://www.guardian.co.uk/business/2011/oct/17/uk-economy-stall-next-year [Accessed: 12 March 2012]. Bbc.co.uk (2011) BBC News - UK economy forecast cut by BCC for fourth time. [Online] Available at: http://www.bbc.co.uk/news/business-15915104 [Accessed: 13 Mar 2012]. Sloman, J. (2004) Economics. New York: Penguin. Telecomsmarketresearch.com (2011) Mobile Phone Sales Trends in the UK Post-Credit Crunch. [online] Available at: http://www.telecomsmarketresearch.com/resources/Mobile_Phone_Sales_Trends_in_the_UK_Post-Credit_Crunch.shtml [Accessed: 13 Mar 2012]. Wolf, Martin (2012) Why cutting fiscal deficits is an assault on profits - FT.com. [Online] Available at: http://www.ft.com/intl/cms/s/0/448bb4e0-15f2-11e1-a691-00144feabdc0.html#axzz1p01xPi5Y [Accessed: 13 Mar 2012]. Read More