The aim of this essay is to discuss the relevance of John Keynes to the current macroeconomic situation in the UK. Macroeconomics can be defined as “the study of whole economic systems aggregating over functioning of individual economic units” (Bannock G, 2003: 236). It considers aspects of the economy from a government perspective such as the general price levels in an economy instead of a price level in a single market. John Keynes and economists who share a similar view to his on macroeconomics strongly believe that an economy will frequently settle below full employment. In such a situation aggregate supply will most likely be price elastic and increases in aggregate demand will mainly affect output. Keynes theory suggests government intervention through demand side policies in order to boost aggregate demand and reduce unemployment. However, Keynes theory is opposed by classical economists who believe that an economy will be at full employment and as a result demand side policies implemented by the government with the intent to boost demand will likely lead to an increase in prices and cause inflation. On the contrary to Keynes’s recommendation classical economist insist government should implement supply side policies aimed at shifting aggregate supply to the right (Gillespie. A, 2007: 307).
The government of any economy will set policies in order to achieve set economic objectives. These economic objectives include maintaining a stable and sustainable level of economic growth, controlling inflation within a certain level, a push for full employment or decrease in level of unemployment within the economy and monitoring the level of the balance of payments (bized.co.uk). Government policy objectives are highly important as they ensure efficient production of goods and services within an economy. The diagrams below display information relating the changes in different economic objectives over the past years.
Inflation can be defined as “an increase in the overall of prices in the economy” (Mankiw G M, 2001: 13). As can be seen from figure 1 above inflation rate has remained stable up till the year 2007. The UK central bank aims to keep inflation rate at 2% and according to figure 1 since the year 2005 to 2007 the central bank has been on or just within their target. Also observed on figure 3 is the stability of the unemployment rate within the same period. Unemployment is defined as “the existence of a section of the labour force able and willing to work but unable to find gainful employment” (Bannock G, 2003: 391). After the year 2007 inflation rate experienced a sharp increase to almost 3% higher than the government target this change was strongly related to the credit crunch within as prior to the economic event house price continued to increase substantially contributing to the high inflation rate but price became so high to the point mass numbers of people began to default on their mortgages which lead to the credit crunch as banks and investment firms became bankrupt this is can be observed on the diagram as inflation rate sharply decrease from the 3rd quarter of 2008. The effects of the credit crunch can also be observed on figure 2 as GDP experience a sharp decline within the same time scale after a long period of relative stability.