Impact of Macro-Economic Policy on the UK Economy
MACRO-ECONOMIC ENVIRONMENT
REPORT:
Impact of Macro-Economic Policy on the UK Economy
CONTENTS
PAGE
Introduction 2
Main Instruments of Macro-Economic Policy:
Monetary Policy 3
Fiscal Policy 4
Supply Side Policy 5
Effectiveness of the Policies:
Monetary Policy 6
Fiscal Policy 7
Supply Side Policies 8
Effects of the Policies:
Monetary Policy 9
Fiscal Policy 10
Supply Side Policies 11
Conclusion 12
Bibliography 13
Appendices 14 - 16
INTRODUCTION
This report aims to illustrate the main instruments of macro-economic policies such as Monetary policy, Fiscal policy and Supply side policies showing their relation to Keynesian and Monetarist approaches.
The report will also discuss the effectiveness of these policies in helping to achieve government objectives.
By using case studies and examples this report will be able to show the possible effects that the policies have on economic agents such as consumers, employees etc.
MAIN INSTRUMENTS OF ECONOMIC POLICY
Monetary Policy
Monetary Policy is when the government use interest rates and the amount of money in the economy to control the economy. Monetary policy can be used to expand the economy during a recession or to restrict the economy during boom.
The diagram below illustrates recessions and booms in the UK economy from 1979 to 1999.
Keynesians believe that continuous mass unemployment can be caused by lack of aggregate demand. After the war Keynesian policy used increased levels of government intervention through budget deficits and fiscal policy to reach a suitable level of aggregate demand to achieve full employment and economic growth with stable level of inflation and balance of payments. If Keynesians believe that the economy is facing a recession, they can use monetary policy to lower interest rates, ease controls on bank lending and hire purchase. During a boom in the economy, Keynesians use the monetary policy in reverse, increasing interest rates and making the controls on bank lending and hire purchase stricter.
Monetarists believe that inflation is caused by an increase in the money supply. They also believe that future expectations of increased levels of inflation cause higher wage demands, which in turn cause inflation. Monetarists feel that governments should control their spending as it effects the money supply and inflation if they spend more than they make from taxes. Monetarists use the monetary policy to ensure a slow steady growth in the money supply which moves in line with the growth of real output, around 1% or 2% per year. The Bank of England controls rates of interest rates, and by holding interest at a steady level, inflation would also be kept level. (See appendix 1)
Fiscal Policy
Fiscal Policy is the policy used by the government to help direct the economy by deciding how much they should spend, which resources to spend money on, how much taxes should be risen or decreased or waived. An example of fiscal policy in use is when the government from 1945 used fiscal policy to change the level of economic activity. After 1979, the Conservatives believed that using monetary policy to control the money supply was more important.
Keynesians use fiscal policy as their main policy as they believe that interest rates play an important part in influencing aggregate demand. They use monetary policy as a back up to fiscal policy. When Keynesians are faced with a recession in the economy, they use fiscal policy to increase public spending and cut taxes. When there is a boom in the economy fiscal policy is used by Keynesians to decrease public expenditure and increase tax.
Monetarists may use fiscal policy to reach a near balanced budget which they feel will prevent large increases in the money supply and inflation. As monetarists do not believe in the short term counter cyclical policies, they feel that it is important to stabilize the money supply in the medium term.
Supply Side Policy
Supply side polices are used by the government in an attempt to change the structure of the economy and to improve the performance of markets and industries. They feel that micro economic factors are important. Economists who use the supply side policies believe that the government should attempt to stimulate output rather than change aggregate demand. Supply side economists believe that by allowing markets to operate freely, resources are allocated most efficiently. Supply side economists feel that trade unions should be less powerful, tax and benefits should be lowered and that state run industries should be privatised.
Incomes Policy
An incomes policy aims to reduce inflation rates by ensuring that the growth rate of incomes is the same as the growth rate of productivity. If the government can slow down the rate of increasing incomes, the incomes policy can restrict the rate that costs are rising. A voluntary incomes policy is when the government tries to persuade trade unions and firms to accept that wages should not be allowed to increase more than the expected rise in Gross National Product. A statutory incomes policy is when the government passes legislation to limit or freeze ...
This is a preview of the whole essay
Incomes Policy
An incomes policy aims to reduce inflation rates by ensuring that the growth rate of incomes is the same as the growth rate of productivity. If the government can slow down the rate of increasing incomes, the incomes policy can restrict the rate that costs are rising. A voluntary incomes policy is when the government tries to persuade trade unions and firms to accept that wages should not be allowed to increase more than the expected rise in Gross National Product. A statutory incomes policy is when the government passes legislation to limit or freeze increase levels.
Price Controls Policy
Governments could apply price controls to control inflation rates. Price controls sometimes hold prices below the equilibrium level, causing shortages. If costs rose whilst prices were held down, firms may be unable to make profit. When cost-push inflation is the main inflation, prices need to be controlled to reduce the problem.
Income Tax Policy
A classical government would believe that tax should be as low as possible creating an incentive for people to work and to encourage new business people to start up as they would not be loosing as much profit to tax.
EFFECTIVENESS OF THE POLICIES
The government has four main macro-economic objectives:
Full employment
Low inflation
Economic growth
Stable and satisfactory balance of payments
The effectiveness of the main macro-economic policies in achieving the government objectives is described below.
Monetary Policy
Keynesians use monetary policy during a recession and in reverse during a boom. Monetary policy is used to lower interest rates, ease controls on bank lending and hire purchase during a recession. (See appendix 2) The effect this has on the government objectives is that unemployment would fall due to increased expenditure causing greater demand for goods and services and more need for employees to produce more goods. Economic growth will rise due to the increased supply of goods and services and the low interest rates encouraging people to borrow and spend. Inflation will increase due to the less favourable balance of payments due to increased spending on imports. (See appendix 3)
During a boom, Keynesians use monetary policy to increase interest rages, and impose stricter controls on bank lending and hire purchase. This causes unemployment to rise as consumers reduce spending due to controls on bank lending and hire purchase. Economic growth would fall due to firms not borrowing money to expand or invest due to increased interest rates. Inflation would fall because the levels of unemployment have increased. The balance of payments would increase as people are spending less on imports than the country is getting from exports.
Monetarists use the monetary policy to ensure a slow steady growth in the money supply which increases in line with the growth of real output. They believe that if the government can ensure that the money supply increases slowly with the growth of output, that unemployment will be able to stabilise itself at it's natural level. Monetarists believe that if employees have excessive wage demands, it may cause temporary unemployment rather than inflation, as if wage prices are too high then the supply of labour will exceed its demand and workers will realise that this doesn't benefit them, and will reduce their demands. Inflation is controlled when the money supply is stable. Economic growth will rise when market forces are allowed to operate freely without government intervention. When the market is operating freely it ensures that the country is not making a deficit in their balance of payments.
Fiscal Policy
Fiscal policy is used by Kenynesians in their counter cyclical policy to increase public expenditure and cut taxes during a recession. They aim to increase consumer expenditure due to the lower taxes, which helps to rise the economic growth although it causes the balance of payments to deteriorate as people spend more money on imports. Unemployment falls due to the increased public spending creating more demand and more jobs to increase the supply of goods and services. (See appendix 4) Inflation will rise due to the increased spending and wage demands.
Keynesians use the fiscal policy during a boom to decrease public spending and increase tax. The increase in tax causes consumers to decrease their spending resulting in rising unemployment. Economic growth falls due to less new businesses as the tax is too high and business may seem unprofitable. The balance of payments improves as consumers spend less on imports. Inflation would fall as less money is being spent in the economy and more unemployment so there would be less wage demands.
Supply Side Policies
Supply side polices improve the supply of resources, and by improving the flexibility of labour and controlling inflation they reduce unemployment. Supply side policies also reduce inflation by de-regulating the labour markets and encouraging higher levels of productivity. Supply side economists feel that unemployment levels would drop when there was lower tax and reduced benefit levels. When unemployment has been reduced, inflation would remain low, and if trade unions had less power, it would prevent workers demanding higher wages, which would also help to keep inflation low. By allowing market forces to operate, supply side economists feel that the economic growth would increase, as goods would be supplied where they were needed. As supply side economists feel that supply factors are important they would concentrate on ensuring there was enough supply for consumers, preventing more imports having to be purchased, helping to keep the balance of payments level steady.
Incomes Policy
By ensuring that the rate of growth of incomes and productivity remains at the same level, incomes policy can help to reduce inflation. By slowing down the rate of increase in incomes, rises in costs can be restricted. (See appendix 5) When income and productivity remain at the same level, there will be less money spent on imports that may help improve the balance of payments. An incomes policy would restrict the economic growth of the economy and restrict the expansions of industry. When industries cannot expand freely, there will be less opportunity for employment, which restricts a decreasing rate of unemployment.
Price Controls Policy
If governments inflation by imposing price controls, it can often cause firms to go out of business if costs rise and prices can't. Firms may be unable to keep employees if costs are rising and they are not making enough profit, causing increased unemployment. Economic growth would deteriorate, as firms may find it difficult to expand. Consumers may purchase goods from other countries if prices are unreasonable causing the balance of payments to decrease, making the UK less competitive.
EFFECTS OF THE POLICIES
This report will now describe the effects that each policy may have on economic agents such as consumers, employees, private sector organisations and public organisations in the UK.
Monetary Policy
Monetary policy would, as suggested by Keynesians, help to reduce unemployment, increase economic growth, cause inflation to rise and the balance of payments to decrease during a recession. The effect that this would have on economic agents is that an increased inflation rate would decrease the disposable incomes of individuals, and reduces the real value of their savings and borrowings. Firms may have to reduce labour costs or export goods from Europe, causing unemployment in the UK. Firms who export goods to other countries would find that the real value of their profits was reduced. Firms would be less willing to invest due to increased inflation, and it would encourage inefficiency.
During a boom, Keynesians would use the monetary policy to help decrease inflation, improve the balance of payments, increase unemployment and reduce economic growth. The effect that this would have on individuals would be to reduced income and reduced standard of living due to the increased unemployment. The balance of payments would improve, as reduced inflation would make the UK more competitive in the markets. The overall economy would be effected, as the government would have reduced taxation levels, as they would be paying out more benefit money.
Monetarists would use the monetary policy to help maintain a steady rate of growth in the money supply, causing unemployment to stabilise at a natural rate, meaning that there would be less unemployed people, improving the standard of living for individuals. Controlled inflation rates prevents individuals from losing the real value of their savings and borrowing. It would also help prevent firms from becoming inefficient and it may encourage them to invest.
Fiscal Policy
Fiscal policy is used by Keynesians to increase/decrease public expenditure and cut/increase taxes during a recession/boom. When they decrease taxes, it encourages people to spend. This contributes the reduced unemployment, increased economic growth, increased inflation and worse balance of payments. Less unemployment means that individuals have better incomes and standard of living. Firms can expand causing the increased economic growth, and the government would not be paying out so much money in benefits to unemployed. Increased inflation would reduce the real value of people's incomes. Firms would be less willing to invest and become more inefficient as people are spending more money.
When Keynesians use fiscal policy to increase taxes, they cause higher levels of unemployment, reduced economic growth, lower levels of inflation and a better balance of payments. Higher unemployment means that individuals are faced with reduces incomes and the society may face increased crime levels and increased health problems. The economy would have reduced demand, causing unemployment to spiral as people have less money and cannot buy goods, causing less demand again. Individual tax payers are paying more to fund benefits for unemployed.
Suppy Side Policy
Supply side policy would reduce unemployment levels through reduced benefits and lower tax. Individuals would benefit from this, as they would not be able to live on the reduced benefits and would seek employment quicker. Reduced tax levels would encourage consumer spending and firms would invest more money, improving the economic growth of the economy. Individuals would have to pay less taxes, as less money would be going to benefits, allowing individuals to have increased income. Inflation would remain low, as trade unions would not have the power to demand higher wages. This would benefit firms, as they would remain more efficient and be encouraged to invest in new business.
Incomes Policy
An incomes policy means that it would be difficult for firms to expand, and they may not be able to employ as many people as they could. This slows down the rate at which unemployment is falling, meaning that individuals continue paying tax to cover benefit money for the unemployed. Firms may not be able to meet productivity level to meet wage demands, meaning that they may have to make employees unemployed. This may have a bad effect on the society in certain areas of the country where industry is the main source of employment.
Price Controls Policy
When firms cannot increase their prices due to price controls, they may not be able to cover their costs. This may lead to firms going out of business, having a devastating effect on the society in small areas. Firms may have to make people unemployed to continue business, meaning that individuals would have reduced incomes and standards of living. If people are unemployed for too long they may lose their skills and fitness, making it harder for them to get back into work. Firms such as steel industries may be forced to close down, and workers may be unable to find jobs in the same line of work. The economy would be unable to expand at any fast rate, and tax may have to be increased to pay benefit money to unemployed. This would reduce individual's incomes.
CONCLUSION
This report has outlined the main instruments of economic policy such as monetary policy, fiscal policy and supply side policies.
The report has described how Keynesians and Monetarists use the policies.
The effectiveness of the policies in achieving the governments four main macro-economic objectives has been investigated and the effects of the policies on individuals, firms and the economy has also been shown.
By researching news articles the report has been able to give evidence of the policies being used by the government.
BIBLIOGRAPHY
Stanlake's Introductory Economics SJ Grant
Essentials of Economics John Sloman
Economics: A Students Workbook J Beardshaw & A Ross
The Macro-Economic Environment Coleg
WEBSITES:
www.bized.ac.uk
www.tutor2u.co.net
www.state.gov
www.mcgraw-hill.co.uk
APPENDICES
Date: 07/12/2000
Topic: Monetary Policy
The Bank of England kept base interest rates constant at 6% following its December meeting. Rates have now been on hold since February.
2 Date: 16/05/2001
Topic: Unemployment
Claimant count unemployment in the UK fell 10,200 to 975,800, taking the unemployment rate to 3.2 percent, the lowest since August 1975. The decline in unemployment plus a continued rise in total employment - suggests that the economic slowdown may not be as severe as has been feared. Average growth remains fairly stable at 5.1% giving the Bank of England scope for further interest rate cuts if it feels the economy requires a further stimulus from monetary policy.
3 Date: 21/05/2001
Topic: International Trade
The UK's trade deficit in goods with the rest of the world hit its highest level in the first quarter since records began in 1697. During the first three months of 2001, the UK economy sucked in £57.3bn of imports in the period and exported £49.6bn, leaving a deficit of £7.72bn, up from £7.6bn in the fourth of 2000. A slowdown in export growth to the United States was partly to blame, but the underlying reasons for this enormous trade imbalance are fairly clear - strong consumer demand and a high exchange rate, which makes imported goods and services relatively cheap. The widening trade gap may persuade the Bank of England that further interest rate cuts are inadvisable.
4 Date: 18/12/2000
Topic: Unemployment
For nearly eight years the British economy has enjoyed falling unemployment. A 5,000 drop in claimant count unemployment in November takes the total level of unemployment to within 42,000 of breaching the politically significant one million mark. Although the rate of economic growth is slowing, next year should see further declines in unemployment. How much further can the jobless total decline? Will Labour's special employment measures continue to take people off the unemployment count? Are we successfully attacking the underlying problems of long-term structural unemployment? These questions remain at the of the economic policy-debate as the New Year approaches.
5 Date: 18/12/2000
Topic: Labour Economics
A study of the 2000 New earnings Survey from economists at Incomes Data services find that the peak in the distribution of gross weekly earnings for people in work this year is between £230 and £240 per week - or approximately £6.00 per hour for those people in full-tiume work. The introduction of the National Minimum Wage has helped to boost the earnings of full-time and part-time people on low incomes. Thus far there has been little significant negative effect on employment - in part because employers have continued to take on extra workers as the economy has continued to grow. Part-time workers fare much worse in the overall distribution of wages. Over 6.2 million people are now in this category. Many of them are in relatively low paid jobs with little or no trade union protection.
4
