The UK Governments Current Macro-Economic Policies - Essay Example

Task Summarise and explain the UK government’s current macro-economic policies that are aimed at resolving the UK’s level of public debt, and improving the level of economic growth. Macro-economic Policies According to BBC News Business (2011), the GDP of the United Kingdom has been falling since the onset of the 2008 recession; though the global economy is on a recovery path, the country experienced a further reduction of 0.2 percent in the last quarter of 2011. This has been attributed to global economic instability, which in turn has caused slow growth in all sectors. The government’s efforts at curbing inflation have borne some benefits, though it should do more should be done since the rate of change in inflation is not directly reflected in the prices of goods at retail outlets. In addition, BBC News Business (2011) asserts that there is a high rate of unemployment in the United Kingdom that requires the government to take comprehensive measures if the situation is to be reversed. Figure 1: GDP of the United Kingdom over the last 18 years (BBC News 2009) The National Institute of Economic and Social Research claims that the levels reached in early 2009 are the worst in the last 28 years. The united kingdom government has taken some fiscal and monetary policy measures in an attempt to reverse the economic situation. According to Warrell (2012), the government has reduced its spending by outsourcing security and other services from private firms as one of the chief fiscal policies. However, several stakeholders claim that the government is not doing enough, and the Institute of Directors is calling for further cuts in public spending, and reduced taxation, which is the other approach to fiscal policy (O’Connor, 2012). In addition to the above mentioned fiscal policies, the United Kingdom government has taken key monetary policy approaches including inflation targeting and quantitative easing. According to BBC News Business (2012a), the central bank lowered the base lending rates in order to encourage banks to lend more to individuals and corporations; however, despite a low base lending rate of 0.5 percent, banks did not increase their lending and the central bank may raise the rates to 0.75 or 1 percent. According to BBC News Business (2012b), the Bank of England decided to use quantitative easing as the other monetary policy approach in order to reverse the economic situation. In early 2009, the bank injected £75 billion into the economy, which had increased to £200 billion by the end of that year. In October 2011 and February 2012, the bank added £75 billion and £50 billion respectively to bring the total amount injected into the economy using the quantitative easing approach to £ 325 billion. Justification for the Government Policies Cutting on Public Spending The United Kingdom reduced its expenditure in an attempt to redeem the national economy and pay of its debts, which is a more preferable approach as compared to the other viable option of increasing taxation. Increasing taxation would have had a negative effect on the already ailing economy, especially since direct and indirect taxes would have reduced the people’s purchasing power. The proceeds of the reduction in spending would have been used to offset the national debts, which would in turn have had the effect of reducing the national deficit on the balance of payments. The ultimate effect of cutting on government spending would be to reduce the amount of national debt without having to overburden the public with the government expenditure, especially since the public was already under enough pressure (Warrell, 2012). Lending Rates At the start of the recession, the central government figured out that reduced lending rates encourages individuals and corporations to borrow money from banks and discourages saving. The rationale was that this money would have been spent in the United Kingdom economy, and end up giving the latter a much-needed boost since an increase in quantity of money in the market increases the rate of circulation by increasing demand as people would be willing to spend more money. However, this did not happen, and various critics have their reasons but it is apparent that the government could not convince banks to reduce their rates, and even if they did, the uncertainties of the economy at the time made them reluctant in giving out their reserves. Since the low rates of up to 0.5 percent do not seem to have much of an effect on the economy, the central bank may raise the rates again since low rates without a corresponding increase in business volume causes losses (BBC News Business, 2012b). Quantitative Easing The central bank credits its accounts with a certain amount of money authorised by the Chancellor, and then spends the money in specified ways in order for the money to be injected in the economy thus increasing demand and supply. For instance, the Bank of England so far has used £ 325 billion to buy government and corporate bonds among other properties from corporations, giving the corporations extra money to spend. Once these corporations have the extra money, they will spend or loan it out to the market, and the United Kingdom market will get the boost it requires. Once the economy has recovered, the bank of England intends to sell the assets it bought and then destroy the money it gets from these transactions. Technically, quantitative easing has the same effect with money printing as seen in Zimbabwe and 1920s Germany in the short run; however, in the long run, the money will be destroyed, and the economy will have recovered without the central bank having to print any money. The bank of England claims in a report that quantitative easing has helped to improve the GDP from 1.5 to 2.0 percent (BBC News Business, 2012b). Commentator Views Many critics are against the idea of quantitative easing, with most claiming it to be an unconventional and untested approach to monetary policy. However, Feldstein (2011) asserts that quantitative easing played a key role in the recovery of the United States from the recession. On the other hand, Thornton (2011) recommends caution when implementing quantitative easing, as there is usually a delay between implementation and the occurrence of the effects in the market. This could result in the central bank not noticing the negative effects of quantitative easing in time to perform corrective measures. According to Lynch (2010), beneficiaries of quantitative easing invest in emerging markets and other non-local markets such that the local economy may not feel the effects of the policy. BBC News Business (2012b) asserts that some critics equate it to the 1920s Germany or Zimbabwe; however, in this case the money is electronic and temporary, so it is unlikely to have a long-term effect like in the two countries. On a lighter note, BBC News Business (2012c) attributes the sharp growth in retail sales observed in the United Kingdom to quantitative easing. In addition, Intute (2007) recommends the government approach of letting the public give their views on policy matters. However, O’Connor (2012) suggests that instead of taking unconventional measures, the government should reduce public spending, which could offer instant benefits to the United Kingdom economy as opposed the quantitative easing that takes years to mature. Warrell (2012) criticizes the government for outsourcing criminal investigation, street patrol and suspect detention, and recommends that the government should outsource on services with less impact on national security. The British Chambers of Commerce (2011) predicted that though economic growth would be slow, and unemployment would be on the rise, the GDP would improve gradually; suggesting that government measures to reverse the economic situation may be successful. Task 2: Sterling is currently at a relatively low level against other major currencies. Explain briefly how this has come about showing the relationship between interest rates and the exchange rate and the possible implications for the balance of payments. Factors Leading to a Weak Pound The sterling has lost up to 30 percent against the American dollar since the recession started in 2008; however, the situation is worse than it seems since the dollar has been losing against other world currencies too. This means that most major currencies in the world are weakening, only that the situation is worse for the sterling mainly due to the following factors: The global recession had a worse effect on the United Kingdom than it did on the United States and Europe at large. The low interest rates in the country and the likelihood that investments based on the sterling have a poor interest outlook. The quantitative easing program by the central bank is another significant factor, mainly by increasing the amount of sterling in circulation in the United Kingdom market, though its effects are expected to reverse in the long run. The United Kingdom has a current account deficit that is not likely to self-correct, mainly because of low volumes of export and the low foreign exchange that the exports fetch due to perceived instability of the sterling (tutor2u, 2012). Investors suspect that the government and the central bank aim to improve exports by weakening the currency, and thus are wary of committing to any long-term investments. Investors also suspect the reluctance by the government to reverse the situation is because a weak currency reduces the value of public debt (This is Money, 2011). Figure 2: Graph showing the high level of current account deficit in the United Kingdom against that of the united states (tutor2u, 2012). The deficit is expressed as a percentage of GDP due to the heterogeneity of different economies. Note that though the United Kingdom has always operated on a high deficit, it did not pose problems before the recession since the country always had the means of repaying the deficit. Effects on Business The current situation of a weak pound encourages investment into the country by local or international investors and increases the volume of import such that it is over and above that of exports. This is mainly due to the increase in the United Kingdom capital account relative to the current account, necessitating upward fluctuations of exchange rates. Therefore, the weakened sterling will encourage corporations to invest more resources in the United Kingdom market, in the hope that the fluctuation is temporary, and the situation will improve in the long run. Increased imports result because of a weakened sterling, which makes imports cheaper than domestic products, and it makes business sense for investors to import substitutes for domestic products since the imports are more affordable to consumers. Figure 3: Graph of major macroeconomic indicators in the United Kingdom and the OECD (OECD, 2011). This graph shows that United Kingdom is a major contributor in the poor economic situation in the OECD countries. The shaded region indicates the maximum and the minimum values of the indicators in OECD countries. However, this does not mean that a deficit is unfavourable, or that surplus is favourable, it all depends on the cause of the deficit and the reversibility of the change. In this case, the current account deficit in the United Kingdom is likely to be unfavourable, mainly because it was caused by a weakening of the currency, and the fact that the fragile nature of the economy may make the situation irreversible in the long run (tutor2u, 2012). Implications for Balance of Payments The United Kingdom has a deficit in its balance of payments due to the weakened sterling, mainly because the country imports more than it exports, and the reducing strength of currency is bound to cause a further deficit. This is mainly because currency conversion makes United Kingdom exports less worth to the outside world than what they are worth in the country, making the balance of payment deficit worse than it could have been when the situation was better. For instance, though the United Kingdom has labour surplus in the architecture and the legal industry, it still is one of the largest importer of services, accounting for more than 8 percent of the total service imports in the world. In addition, the weakened sterling has weakened the manufacturing industry since there are cheaper markets where the costs of manufacturing are lower; which has reduced the number of options available for consumers. The overall result is the promotion of imports at the cost of local goods, which jeopardises jobs and living standards in the medium to long term (Sloman, 2004:557). However, investors should be wary of the high rate of debt both in the public and the private sector, and the high rates of unemployment. The positive change seen in the economy may turn for the worst if the times for the debt-driven investments to pay back their debts. this means that though the quantitative easing may create an illusion of recovery and better times, the benefits may be reversed once the central bank takes back its investment. The major reason for this is that the economy will be having money for business, but the private and public sectors will be too debt-ridden to be sustainable in the long run (OECD, 2011). Task 3: Your manager would like to know your views on the following: a) The possible outlook for the UK economy over the next two years b) The implications of this situation for your chosen industry Task 3a: Future Trends in Economy The economy will not suffer from recession anymore; however, it will experience improvements and declines with each quarter, and the average difference will be about 1 percent. In the next one year, the economy may experience slow growth that may get faster at the start of the next year, which will result in a vibrant economy that will increase the aggregate demand and necessitate an increase in supply. As firms readjust to the changed market environment, they will keep their work forces at a minimum in an attempt to keep down costs and wait for the change to be permanent, which will result in sustained high levels of unemployment. Since the economy will not have stabilised within the next two years, it is unlikely that the interest rates on savings of loans will increase since it would be destructive to the already fragile economy. However, the improvements or depreciation of the economic status cannot be predicted effectively because of numerous factors including changes in supply of oil (Sloman, 2004). Many investors will want to do business due to the perception of stability after one year or so; this is because they will be cautious that the economy may make a turn for the worst immediately after they have committed their resources. After one year, more business personalities will be willing to risk investing; a factor that is mainly attributable to the availability of capital from the quantitative easing program. On the other hand, inflation may be exacerbated due to an influx of currency in the United Kingdom market; which is discouraging for short-term investors who would want an early return on investment. Long-term investors will get to take advantage of the governments monetary policy, especially since they will be willing to wait for the negative effects of the quantitative easing to be reversed (Sloman, 2004:517). Justification of the Predictions According to tutor2u (2012), the housing sector is the first to experience slowed growth due to the interest rates and the likelihood is that this trend will spread to other sectors of the economy; a phenomenon that is caused by reduced demand due to small changes in interest rates. This shows that the government is unlikely to increase interest rates within the next two years due to the fear of offsetting an already unstable economy. In addition, the sterling will continue to depreciate, which is advantageous for the United Kingdom industries, as they will have the capacity to compete with foreign companies. BBC News Business (2012b) suggests that the government’s monetary policy will result in higher inflation; however, this will be accompanied by a steady increase in GDP, which the economy will retain after the inflationary effects of the monetary policy have been eliminated. O’Connor (2012) comments that public spending takes up more than 45 percent of GDP, but the Office for Budget Responsibility intends to decrease it gradually over the years. This means that, with each passing year, there will be an improvement in the United Kingdom economy and national debts will be reduced as the country reduces current deficit. According to BBC News Business (2012), the central bank predicts that the economy will have a zigzag growth, and the business environment will be unstable due to alternating increases and decreases of demand and supply. Task 3b: Potential Economic Issues for Industry Figure 4: Graph of aggregate demand and supply (OSullivan and Sheffrin, 2003: 307). Thi graph shows the partial proportionality of aggregate demand and supply, and a firm should not count on increased demand of products to translate to direct demand for its products. Factors Affecting Supply The fluctuating economy will cause suppliers to retain high prices due to uncertainties and risks of doing business in such an environment; however, this will change after some time as the economy becomes more dependable. Since the sterling has reduced strength in comparison with other currencies, it will be easier for new players to get into the market, which will necessitate that Orange should change tact especially since price and cost competitiveness will be reduced (tutor2u, 2012). Once the economy gains momentum, there will be increased demand for services, as consumers will have enhanced purchasing power, which necessitates that Orange expand its network coverage to cater for the increased demand. In addition, higher purchasing power will enable consumers to use more services from the firm, and it should expand their service portfolio in line with changing trends, tastes and preferences. For instance, it should enhance the quality of customer service to give it a competitive edge against other firms in the market. High rates of unemployment will give firms a cheap source of labour, and thus the firm will be able to provide extra services at little or no extra cost (O’Connor 2012). In addition, reduced interests will give the business a cheap source of capital, which in turn will reduce the overall costs of doing business; this may translate to increased competition in the industry. Factors Affecting Demand Once the economy takes a turn for the better, people will earn more from their workplaces or their private businesses, and this will increase their capacity to spend. This increased demand for Orange services and the firm should work to ensure reliability of its network; failure to which customers will seek the services of emerging market players whose networks will not be congested. However, there is a risk of increased spending in an unstable economy as customers will not be assured of their income, and the United Kingdom population will be spending more than it earns (tutor2u 2012). Though this may be advantageous to firms in the short run, the firm may lose out in the long run as customers readjust to the reality that they may not afford as much as they would want. Reduced costs of doing business will cause an influx of many firms that will push the already low prices further; and customers will have to choose their providers using other criteria other than price. This is a chance that Orange should capitalise on, especially by brand marketing and product differentiation (Samuelson and Marks, 2003). Justification Orange should embrace highly volatile economic times, especially since the mobile network sector that falls in the services sector. BBC News Business (2012d) states that the services sector has been experiencing the fastest growth rate in 4 years, and the mobile sector is set to benefit from this growth that is set to be sustained for a long time once economic recovery is well on the way. This is because the services sector accounts for over 70 percent of the total United Kingdom output. Therefore, if this key sector experiences growth, then economic recovery is imminent, and as BBC News Business (2012d) states, further recession is highly unlikely. However, this does not mean that the economy will be on an upward trend all through, as the United Kingdom economy must have its troughs and crests like any normal economy. In addition, the macro economy is highly dependent on the political, social, technological, and other factors, such that the firm cannot trust the economy enough not to be wary of changes (OECD, 2011). This means that resources should be committed to research and development to enable orange to be prepared in case of any changes, and in order to avoid the negative effects resulting from these changes (Blanchard, 2011). According to O’Connor (2012), all leading stakeholders agree that the £325 injected into the economy as a monetary policy measure is enough for a full recovery, and there is no need for the Bank of England to use quantitative easing any further. However, stakeholders warn that firms should be wary of the current economic instability since it is likely to fluctuate positively and negatively over the next few years before it eventually stabilises. On the other hand, these stakeholders warn that if the Bank of England injects any more money into the economy, then the economy may never recover from the ensuing inflation. The recommendation for Orange is that the management should take calculated risks, and only use resources they can afford to lose in their strategies. 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