macroeconomic policy measures introduced by the UK authorities in response to the global credit crisis and associated UK recession
Macro-economic policy measures
This essay is based on two scenarios of financial crisis that occurred consecutively in the United Kingdom and other parts of the World. The recent economic recession started in 2007 up to 2010 while the credit crunch was experienced in 2002 up to 2004. In both of the financial crisis what were witnessed were reduced employment levels, collapse of major sectors of the economy mostly the financial sector, high prices of goods and services brought about by high inflation rates, low economic productivity and a deficit in the balance of payment coupled with a general decline in the country's gross domestic product.
According to Dale, Proudman and Westaway (2010) the causes of the recent economic depression and the earlier credit crunch are more or less similar to one another. As in both crises regulatory laxity was first to be blamed, followed by other factors such a rational market behavior and the poor financial performance of the housing industry, among others.
The essay intends to analyze the mechanisms and briefly evaluate the effectiveness of the macroeconomic policy measures introduced by the UK authorities in response to the global credit crisis and associated UK recession.
To start with the study will identify some of the policy measures that were used to address both the credit crunch crisis and the subsequent recession. Secondly in the literature section the study will highlight on impact these measure should have had and thirdly in the evaluation section, the effectiveness of these measures will be evaluated before the essay comes to a conclusion.
Buiter (2010) noted in his publication in the oxford review of economic policy, that during both the credit crunch crisis and the recent economic recession witnessed in most parts of the world, the United Kingdom government introduced a number of macroeconomic policies measures that were categorized into three groups, namely the fiscal policy measures, monetary policy measures and supply side policy measures, all of which were meant to control the crisis and lead to economic recovery.
In the two scenarios it would have been inappropriate to consider the re-evaluation of the macro economic policies, because according to Dooley and Garber (2009) the credit crisis and the economic downturn that was experienced World wide was largely contributed by laxity in these financial regulations. Consequently, UK authorities opted for an expansionary fiscal policy because monetary policies that were in place only promised higher inflation rates in the future, in addition they also opted for the development of new and more effective monetary policy measures.
Through the fiscal monetary expansion the government increased its' spending in a bid recover from both crisis and also increase the economic output, demand for goods and services and the employment levels. Important to note is that in the early phases the government introduced precautionary measures due to fiscal implementation uncertainty and lags. According to Chung, Davig and Leeper (2007) the overall objective of the government in introducing the stimulus plan concurrently with the expansionary fiscal policies was to gradually lower the government debt and GDP ratio.
In this section the study looks at how these policies that were introduced during both crises were expected to affect the economy. Dooley and Garber (2009) and other economic analysts pointed out that through the fiscal policy expansion which was an increase in government spending with only a minimal government borrowing, the UK authorities expected an increase in national income as well as the gross domestic product. The stimulus plan that was introduced by the new policies and which was channeled towards mostly financial institutions and the ailing sectors of the economy was expected to lower the interest rates that would have eventually lead to increased spending of business capital and also increased consumer spending. Larger capital stocks would have resulted from increased investment spending, which consequently was expected to increase the UK's national income.
Eggertsson and Woodford (2003) demonstrated in their studies using the IS-LM model, which is tool used by economists to explain the relationship between interest rates and real output in the service and goods market and the money market. Using the model they demonstrated on how the UK authorities expected through the newly introduced macroeconomic policy measures to get a general equilibrium in both the money market and goods and services market. The equilibrium was to be influenced by factors such as investments, savings (IS) and Liquidity preference, money supply (LM) that are controlled by macroeconomic policies.
Referring to the economic literatures written by Kirsanova, Leith and Wren-Lewis (2009), the macroeconomic policy measures introduced during the credit crunch and the recent economic recession were expected to manage the aggregate demand in the overall economy. This consequently has an influence on the inflation rates, employments levels, increasing the national income and creating equilibrium in the balance of payment. The reflationary policies such as the fiscal stimulus package and the expansionary fiscal policy aimed at increasing the aggregate demand in the economy and the level of spending during both times of financial crises.
According to Leeper (2008) the macroeconomic policy measures that were adopted during the economic down turn and the credit crunch not only in the United Kingdom but by all other countries, were meant or were expected to create equilibrium in the balance of payments of these countries, sustain the economic growth that was initially in progress, lower the inflation rates with stable prices of goods and services, increase the employment levels in each respective country, improve the overall living standards of their respective citizens and lastly re-establish sound government finances.
According to statistics released by the UK government, they show that before the onset of credit crunch which was followed by economic depression in the periods between 2007 and 2010, there had been a commendable macro-economic stability witnessed in the country in the past few years. The credit crunch and economic depression as seen below caused a massive decrease in the country's employment level, prices of commodities went up, which was coupled with increased rate of inflation and the growth of gross domestic product also declined.
In 2009, Gordon Brown's administration introduced macroeconomic policy measures that also included the golden rule, which stated that the government's expenditure on goods and services currently provided should be financed by tax revenues. All of these measures adopted by the government as can be seen from the graph resulted into increased growth of the gross domestic product, low positive inflation rates and increased employment levels from the beginning of 2009 henceforth.
Reports also showed that during the period the government increased its borrowing to finance its expenditure budget; this resulted into a deficit in the national budget. Schmitt-Grohe and Uribe (2004) have come out in the defense of successive UK governments' expenditure and borrowing as a response strategy to both the financial crisis. They suggest that a deficit budget has in the long run a positive effect on the macro economic of the country if the budget expenditure was channeled towards financing extra capital spending that result to an increase in the national capital stock. In the case of UK, the big fiscal stimulus was channeled towards transport infrastructure that was meant to improve the supply-side capacity of the country's economy. Also the increased expenditure on education and health sectors has a proven positive effect on employment and productivity of the country.
Schmitt-Grohe and Uribe (2004) justified their claim using the IS-LM model as shown below:
The IS curve represents various combination of the rate of interest and income which equate savings and investments, and LM curve represents the various combination of interest and income which equate demand for and supply of money. National income or GDP is represented by the horizontal axis and interest rate is represented by the vertical axis.
The effectiveness of the British government's deficit budget is well demonstrated by IS-LM model. In using the fiscal policy that leads to deficit spending by the government, it will transpire to increased private investments and lower saving rate. Both will increase the aggregate demand in the economy at each individual interest rate. Thus the government's increased deficit causes the IS curve to shift to the right, this results to equilibrium interest rate moving from i-1 to i-2 and real gross domestic product moves from Y-1to Y-2. Increased government spending or borrowing has the overall impact of increasing the country's GDP and hence it effectively helped UK to come out of the financial crises.
Wren-Lewis (2008) among other economist apparently notes that budget deficit can act a tool for demand management. Increased borrowing can be a useful stimulus to demand when other segments of the economy are ailing. The fiscal stimulus offered by the British government has resulted to stabilizing demand and output during times of financial crisis.
After a though analysis of both the credit crunch…