In addition, the Classical economists deny the fact that unemployment must exist since classical economists believe the self correcting system of an economy. It considers that unemployment can be considered as an interim disequilibrium since it is a balance caused by redundant labor. (Patil, 2010) While in Keynes’s theory, it held essentially that insufficient demand causes unemployment and government must take measures to insure a sufficient demand in order to reduce unemployment. (Sloman, 2007, P254)
In Keynes's theory, Keynes used a 45°line model to discuss the economy's equilibrium level which is the relation between consumption and consumers' disposable income. (Sloman, 2007, P254) In this model, it refers to individual consumptions on domestic products(C), private investment (I), government expenditure on domestic products and services (G) and net export (NX) which constitutes Aggregate Demand (AD). The formula of Aggregate Demand is AD = C + I + G + NX. In one sense, Aggregate Demand can impact the balance of economy. (Sloman, 2007, P256)
In September 2007, the global economic crisis started to show its effects. Around the world stock markets have collapsed, and the real estate crashed. In the meantime, governments had to rescue their financial systems. (ablemesh.co.uk, 2007) The reason is bank lend money to people who may not afford their mortgages. However, they were still happy to lend because all the money is from governments. These lenders could regulate interest rates and make money on sub-prime loans. If the borrowers reimbursement, banks could sell the house in order to get the loan back. Unfortunately, lots of people which had a bad credit histories got the loan but could not repay the loan. Because of this, a profusion of property on the market therefore the prices of property plummet. (Shah, 2009) Anyway, the credit well dried and the housing market declined.
With the Keynesian 45°line model diagrams in next page (Diagram 1), it will explain the economic situation clearly and find the best measures which can help promote economic increasing.
Diagram 1:
Keynesian 45°line model diagram
In diagram 1, the vertical axis is Cd (consumptions on domestic products); W (withdrawals), J (injections) and the horizontal axis is Y (income). In the diagram, Line 1 represents national income; line2 represents aggregate expenditure and line 3 represents consumptions on domestic products. (Sloman, 2007, P255)
From Keynesian 45°line model diagram, there is a distance between point h and point g which means national income exceeded aggregate expenditure and the distance can be called deflationary gap. It illustrates that people would purchase fewer but the products are still produced. Firms will find the stocks could not be sold. Therefore the business had to decrease the level of production and dismiss employees. In this way, national income and expenditure would both decrease. There would be a movement down and the gap between Y and E becomes smaller until to point Z, Y= Z. (Sloman, 2007, P256) With the purpose of putting the economy to the equilibrium position, there are some measures combine the diagram below.
Diagram 2:
From diagram 2, improve the aggregate expenditure is able to return the economy to the equilibrium position. Due to E= Cd + J and J= Investment + Government expenditure + exports. The most efficient method is improving government expenditure. In this way, the injections increase with government expenditure, the aggregate expenditure is increased. Besides, because of E= Cd + J and W= Save + Tax + imports. If government reduces taxation, withdrawals will decline. Theoretically, people will consume more which causes Cd increases. As a result, the aggregate expenditure is increased. With these fiscal policies by governments, the deflationary gap can be eliminated. (Sloman, 2007, P255)
Actually, many governments carried out those policies in order to solve the economic crisis, such as UK. First of all, there are some data that can show the economic conditions in UK in 2008 and 2009. From diagram 4, in the third quarter in 2008 the GDP fell 0.93%. GDP growth was -1.8 per cent in 2008. UK economy is currently in an official recession. (, 2010) However, by the end of 2009, the GDP of UK rise 0.44 per cent.
Diagram 3: GDP of UK
(, 2010)
UK unemployment was 1.92 million between September and November in 2008, up131, 000 from the previous three months, the highest level since September 1997. In addition, unemployment is likely to rise to close to 3 million by the end of 2009. (Seager, 2008)
Diagram 4: UK Interest Rates
Interest rates have fallen significantly in 2008. After the economic crisis, the interest rates kept falling until 0.5 percent which is the lowest rate in the history. All the data illustrates UK was affected by the current global economic crisis. Nevertheless, from diagram 3 we can find that the GDP of UK was positive in 2009 Quarter 4 and 2010 Quarter 1. It means the economy of UK started to recover and government did a good job to boost economy.
In order to revitalize the economy, the British government instituted some fiscal policies. Due to the fact that UK was affected the US sub-prime crisis, which caused people to lose confidence in financial industry. From the data above, 1.92 million people lost their jobs between September and November in 2008. (Seager, 2008)Also, as the result of the mass unemployment, people did not want to investment into the business or borrow from a bank. Majority of people prefer to save money. Therefore, “The Government has begun nationalizing the British banking industry, pumping £37 billion of taxpayers' money into HBOS, Royal Bank of Scotland and Lloyds TSB”.( Porter, 2008) It could reduce borrowing costs, improve private credit market environment.
Moreover, the total government public spending in UK is 575 billion in 2008 and 631 billion in 2009 which means British government increased government spending about 56 billion in order to stimulate the economy. (Chantrill, 2010)Due to the multiplier process, the increased government spending could promote the can promote the development, energetically exploring the consumption area and expanding domestic consumption demand. Besides, it could absorb the workforce and stimulate market purchasing power.
In addition, total Government Net Lending/ Borrowing (National Currency) for United Kingdom is GBP -152.032 billions in 2009. In the previous year, 2008, total Government Net Lending/ Borrowing (National Currency) for United Kingdom was GBP -69.78 billions Total Government Net Lending/ Borrowing (National Currency) for United Kingdom in 2009 was or will be 117.89% more than it was or will be in 2008. The reason is that the British government has to boost the national economic by large public borrowing. In March 2009, the interest rate was 0.5%. However, the dramatic cut in interest rates could not help UK out of the economic crisis. Therefore, British government had to turn to fiscal policy in order to stimulate economic.
Overall, the majority of the policies such as cutting tax, increasing government expenditure and external debts by the British government are designed with Keynesianism. Therefore, the Keynesian theory can help government recover economic to some extent. However, there are some other policies which could not meet Keynesian theory such as cut interest rates, and this monetary policy could not help UK out of a recession. Consequently, government should make rational use of Keynesian theory and avoid the negative policies. In this way, the economic crisis can be abated.
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