Macroeconomic Environment of Business - Fiscal Policy - Case Study Example

Macroeconomic Environment of Business - Fiscal Policy 1. Describe the 2008-9 recession and identify the effects it had on the economy As a result of recession, both the UK and the USA faced falling employment trends in the period between 2008 and 2009. Comparing the three countries; USA, UK and Eurozone, the UK experienced the least cases of unemployment followed by the USA. This unemployment was followed by high rates of falling inflation. The US was most affected with inflation recording the highest rates among the three countries. This trend is closely associated with full employment mandate as well as price stability of the central bank. The low unemployment rates, stable growth and low inflation that had been witnessed in the late 90’s turned into financial crisis which adversely affected the economic growth and resulted to unemployment. Though some recovery was experienced in 2009, recession continued to falter in the UK and Eurozone (Buietr 2010). 2. Explain how fiscal policy could be used to encourage recovery from the recession. In an effort to reduce debts and deficits, the euro area tried to ensure that its fiscal stance was neutral. The stance became restrictive as the recovery from recession was gaining momentum in individual states. Eurozone dealt with recession by offsetting its private sector and encouraged structural reforms in areas such as labour markets, pensions, product markets, and other public finances sector. By doing this, Eurozone was able to increase its economy growth potential as well as its flexibility to crises. The USA and UK fiscal policies were aimed at restoring the economy confidence through streaming debt trends into paths that the countries could sustain and ensure the deficits experienced earlier went back to a GDP that was below 3%. This called for structural adjustment every year which led to GDP levels that were above 0.5%. Deep budget cuts had to be done by most countries like Ireland, Italy, Spain, Portugal and Greece in an effort to deal with the recession. Even countries believed to be experiencing fiscal positions that were sustainable like Germany were forced cut down on their respective government deficits (Crook, 2011). 3. Consider the limitations on the use of fiscal policy, particularly at the moment. Despite the fiscal policies efforts by different governments to deal with the increasing recession, the efforts were met with several limitations. For example, the fiscal policy of the US government entailed increased expenditure demanding for extra expenditure into its economy. The expenditures were on energy independence, infrastructure projects, tax relief, health and education. Despite these measures, minimal progress was experienced mainly because of the decision making gridlock resulting from different political positions. Some of the plans failed to take off due to the same conflicting political stands. Different governments had different fiscal policies thus limited time to implement the already established fiscal policies. A good example is the coalition government that came to power in the UK which accommodated both the liberal and the conservative. This government had a completely different fiscal policy which called for a reduction in its structural deficit through cutting down on its spending instead of increasing taxes (Giles, 2012). 4. Explain how conventional monetary policy could be used to encourage recovery from the recession. Monetary policy is believed to have great influence on most country’s macro-economy through changing the prices and availability of credit prices or interest rates. Monetary policy actions target the interest rates and money supply. In situations where the supply of money is fixed, interest rates are bound to rise. This policy controls the supply of money as a means of checking on inflation. To control recession, the monetary policy has its focus on interest rates that have been adjusted and inflation. Monetary policy is more realistic than other nominal interest rates. This follows the value associated with the diminishing of loans with inflation and other household incomes. At the same time, business revenue tend to rise as inflation increases with increased loan payments (Lenza and Reichlin, 2010). 5. Consider the limitations on the use of conventional monetary policy in these circumstances. Though the monetary policy was the main mechanism employed to control inflation, the economic activities and money supply relationship proved to be unstable and also it was difficult to have money supply in control. This rendered the conventional monetary policy ineffective during recession. With the nominal interest rates always being positive, in situations where the interest rates tend to zero, it is almost impossible to simplify the monetary policy any further. The USA, the Eurozone and the UK experienced rates that were so close to zero during the recession period. During recession, it is common for households to be concerned about their businesses, jobs and income trading conditions and are likely to go for a borrowing increase. This is a common situation in the USA and the UK with both facing very high debt levels of households leading to increased business rates. The situation is even worse in other countries like German where household debts have assumed a falling trend with business debts rising marginally. Compared to the other indebted nations, the USA has stood out as the most successful in her efforts to reduce such debts (Licas, 2003). 6. Explain what unconventional monetary policy has been used and how this was supposed to work. Following the limitations associated with the monetary policy that was conventional, a better unconventional policy was introduced. Also referred to as the quantitative easing, this monetary policy involved having more money directed into the economy through the purchase of government securities that were long termed. This could also be achieved by permitting banks to borrow money using bonds from the government as security. Normally, central banks are not in a position to directly purchase government debts, to avoid this restriction; the banks have opted to buy such debts from private holders and not those from the government. The unconventional monetary policy is intended to; cut down on the long term interests rates and ensure that money supply increases (Trichet, 2011). These measures are aimed at increasing borrowing and private lending. Private lending was inhibited by both supply and demand now that the banks were trying to restore their reserves and capital as a reaction to the bad debts they were facing during inflation. The banks also took this initiative following the reserve conditions that were on the increase so as avoid crises in future. The new monetary policy is also intended to lead to cheaper government borrowings making it possible for governments such as the UK and The USA to fund massive government deficits at rates that are remarkably low (Macintosh, 2011). 7. What are supply side policies? Consider the contribution these may make to resolving our current economic problems. Supply side policies are attempts by the government to better its productivity and have its Aggregate Supply (AS) shift towards the right. Different governments have employed this policy in an effort to find solutions to their economic problems as the policy ensures; lower inflation rates by having the AS shift to the right leading to price levels that are lower. Supply side policies shape the economy to be more efficient thus a reduction in inflation caused by reduced costs. These policies also lead to lower unemployment rates by reducing frictional, real wage and structural unemployment thus reducing unemployment naturally. Supply side policies also improve the growth of the economy through increasing the AS which in turn increases the economic growth. Supply side policies when employed by governments lead to balance of payment and improved trade through having the firms be more competitive and productive thus in a position to export more (Wolf, 2011). 8. Identify any differences between the Eurozone, the UK and the USA in macroeconomic policies adopted to encourage recovery from the recession. The USA, the UK and the Eurozone, all have experienced debt issues in their respective governments in relation to their currencies as a better percentage of these debts were domestically handled. The percentage GDP of the different governments rose at different rates. As the economic growth grew in the respective governments after the recession period, the revenue expenditure increased at varying rates as well as the GDP sizes in comparison with the countries debts. All the three countries faced a significant deficit in their economies during recession. The deficit experienced by the UK and the USA was a surplus while Eurozone faced a whole deficit. This led to the three different countries to have different positions financially as their financial positions deteriorated (Wren-Lewis, 2011). 9. Is there any evidence of different outcomes from these differences in policy? The recession resulted to financial crisis and rapid deterioration of their finances. This situation was worse in the USA and the UK as compared to the Eurozone. By the end of 2009, the deficit experienced by the USA was 11.5%, that experienced by the UK was 11.4% while that of Eurozone was 6.4%. Despite the varying rates, these deficits were taken as being large and further measures had to be employed unless the deficits were to remain substantial. The countries also experienced different structural balances with the UK experiencing a structural deficit estimated to be around 5.5% in the period between 2009 and 2010. This was higher compared to the structural balances witnessed by both the USA and the European (Krugman, 2010). 10. Assess the political pressures and social issues that might constrain governments from following a purely ‘economic solution’ to their most pressing macroeconomic problems. Some of the social issues constraining most of the governments from attaining their economic solutions as they face macroeconomic issues include; development and unemployment, social security, gender equality, social security and financial security. The challenges on social security systems have affected most of the countries in many ways. The systems are either too expensive that they interfere with the economic development and growth process or lead to increased cases of unemployment and labour insecurities. Political pressures are witnessed when it comes to the policies enacted by different governments such as the monetary policies. Conflicting government positions may lead to some of the policies to fail to pass or not to be fully implemented (Brown, 2006). Bibliography Brown, G. (2006). ‘Full text: Gordon Brown’s budget speech 2006.’Guardian. Retrieved on 9th April 2012, from: http://www.guardian.co.uk/uk/2006/mar/22/budget2006.budget Buietr, W. (2010). ‘The Limits of fiscal stimulus’. Oxford Review of Economic Policy.70 Crook, C. (2011). ‘A fiscal policy fit for the next crisis’. Financial Times. 27 June. Giles, A. (2012). ‘Britain’s best new export: Lessons in intelligent fiscal policy’. Financial policy. 2 February http://www.nytimes.com/2010/07/02/opinion/02krugman.html Krugman, P. (2010). ‘Myths of Austerity.’ New York Times. Retrieved on 9th April from: Lenza, M. & Reichlin, L. (2010). ‘Monetary in exceptional times’. Economic Policy. 295-339 Licas, R. (2003). Macroeconomics priorities, Presidential address to the American Economic Association. University of Chicago Press: Chicago. Retrieved on April 9th from: http://home.uchicago.edu/~sogrodow/homepage/paddress03.pdf Macintosh, J. (2011). ‘Quantitative easing dies it, but only to a point.’ Financial Times, 25 June. Trichet, J. (2011). The monetary policy of the ECB during the crisis. Retrieved on 9th April from: http://www.ecb.int/press/key/date/2011/html/sp110606_1.en.html Wolf, M. (2011). ‘Times has come for some intelligent policy making.’ Financial Times. 14 October. Wolf, M. (2011). ‘Why this fiscal policy is a huge gamble.’ Financial Times. 29 April Wren-Lewis, S. (2011). ‘Lessons from failure: Fiscal Policy, indulge and ideology.’ National Institute Economy Review. 217:31-46 Read More