The mechanisms and effectiveness of the macroeconomic policy essay
The macroeconomic policy measures are the response of the national government to the negative economic situations and influences. Two important tasks of the UK policymakers include the control over the shocks’ impact and also the regulation of the reaction of the country’s economy to the shock. Therefore, in order to fulfill these tasks, the UK government aims to create the stability-oriented policy framework in order to build the stable environment for the stable economic growth. (Barrell and Davis, 2005) This essay reviews the mechanisms of the macroeconomic policy of the UK authorities and aims to estimate their effectiveness.
Introduction
The current unfavourable economic and financial circumstances demand the professional control over the macroeconomic situation both globally and locally. The UK government has to be able to form the virtuous response to the negative externalities and introduce the policies that would help to absorb the impact of the economic shocks. This way the economy will be prevented from the possible negative consequences of the financial crises such as European sovereign debt crisis or the global credit crisis. It should be specifically noted that the UK economy is interconnected with the economies of the other EU members and it means that it’s subjected to the influence of the current negative processes within EU when few countries are unable to repay their borrowings. These economic and financial problems require the support of the stronger members of the union.
The present essay is an attempt to evaluate the recent UK macroeconomic policy measures’ effectiveness. It should be noted that discussed measures were adopted under conditions of current complex economic situation. The UK institutions efforts include the monetary and fiscal policies prepared in order to timely and correctly respond and regulate the economic and financial development of the country.
Barrell and Davis (2005) claim that the country’s ability to react to shocks is crucial and its one of the major elements that keeps the macroeconomy in a stable position. These shocks may have different nature and various causes, but in any case they need to be absorbed and it will result in the better economic and financial performance of the country.
- The recession
The right response to the recession can’t be made without the theoretical knowledge of the recession process. For instance, theorists Arestis and Baddeley (2001) focus their research on the efficiency of the international financial markets and they research the question why so many financial crises have happened since 1970s? Authors conclude that before that time the financial system was formed in accordance to Keynes’s thesis that “international capital mobility and rapid economic growth are incompatible”. The capital was better controlled and financial market was more strictly regulated. But since that time, since the liberalization of the financial market, the financial system has become much more instable and suffers from international debt and currency liquidity crises threatening the stability of the global economy. (Arestis and Baddeley, 2001)
Before considering ways of dealing with international financial crises, it’s necessary to understand why they arise, what role they play in international capital markets, and whether they can be detected. There may be a range of fundamentals over which an economy is susceptible to crisis. The crisis mechanism lies in the self-fulfilling beliefs of international lenders and results in multiple equilibrium.
Diamond and Dybvig highlight the role of maturity mismatches in generating multiple equilibrium. (Chui and Gai, 2005)
Summers (2000) observes that real-life crises contain elements of both belief-driven and fundamentals-based attacks. The likelihood of crisis is often determined by the extent of fundamental weaknesses that call into question the sustainability of domestic policies. (Chui and Gai, 2005)
Morris and Shin (1998) suggest that it is possible to resolve the problem of indeterminacy in beliefs, and capture the key elements of the two views of crisis. They highlight two shortcomings of multiple equilibrium models. (Chui and Gai, 2005) First, economic fundamentals are assumed to be common knowledge; and second, creditors are assumed to be certain about others’ behavior in equilibrium. Once disparities in the information sets of market participants are allowed, a creditor’s decision to withdraw depends on his private signal about fundamentals and his assessment of the probability that other creditors have received a better signal. If the signal is below a certain trigger value (determined in equilibrium), then it is optimal to run. And if a sufficient number of creditors have signals below the trigger value, a critical mass of withdrawals is reached starting a crisis.
The weaker the fundamentals, the more fragile the situation becomes in the sense that fewer participants are required to trigger a crisis.
Chui and Gai (2005) indicate that the global games approach to the financial crises perfectly applicable to the recent shocks.
Two elements of the macroeconomic policies presented by UK authorities include the monetary and fiscal policies.
The institution responsible for the monetary policy is the Bank of England. “The central bank controls money supply for monetary policy. If money supply is controlled they control the interest rate. Increasing the money supply reduces interest rates and vice versa. The money supply is the government’s measure of controlling monetary policy, and government expenditure is the way they control fiscal policy in the economy. “(Prof. Andros Gregoriou Lecture 6, IS-LM)
I need to sum up that the monetary policy uses different monetary tools (for instance, interest rates) and thus makes the positive influence on the processes of spending and demand in the economy.
When discussing the monetary policy in the UK, it should be specifically noted that the general goal is to keep the inflation within 2% +/-1. Besides it, the other variables that are accounted in this case are growth and the level of unemployment.
The major institution that deals with the monetary policy in the UK and is responsible for the interest rates setting is the Monetary Policy Committee of the Bank of England (but I have to mention that these rates have to correspond to the government targets).
Another vital part of the monetary policy is the research of the inflationary trends that includes the analysis of a number of various factors, such as, unemployment level, GDP, house prices, consumer trends and other. (Appendixes 1,2 & 3) Depending on these figures the authorities make a forecast about the inflation trends, will it rise or fall in the future.
Following the results of inflationary trends research the Bank of England makes a decision. The expectations of the higher inflation mean that the national interest rates will likely to be increased. And on the contrary, the lower inflation is more likely to cause the increase of interest rates.
The monetary policy is especially important when the national economy faces a recession. Common measure of the Bank of England under these circumstances is to cut the interest rates and according to the economic theory this step should stimulate the national economic and consequently increase the income of the citizens which should in (and this measure will encourage further spending).
- Current situation and forecasts
According to the latest news (Washington Post, The Telegraph), the monetary policy provided by the Bank of England will not be changed and despite the current concerns the main interest rate will be kept at 0.5% which is considered a low rate.
Some analysts draw attention to the fact that the current inflation rate is 5% which is too high (especially comparing it to the planned 2%). This figure is explained by the faltering economy and the many analysts indicate that inflation will be much lower than the present one later this year. (Pylas, 2012)
As previously, when the UK had to face the credit crunch influence, the UK authorities rely on cost of borrowing reduction and the attraction of the money flow. Thus the national consumer demand and investment will be stimulated. (Pylas, 2012)
It is known that the further development of the UK market critically depends on the situation in the other EU members and how the way debt crisis in the euro zone will be solved. The situation in the EU is a crucial factor for the UK economy because the EU is the largest export market for our country and they are seriously interrelated.
This part of the paper will be based on the respectable opinions of the leading financial institutions that commented the results of the UK’s macroeconomic policies as the response to the economic crises. (BBC, 2011)
The IMF, the world known institution, has commented on the UK’s macroeconomic policies undertaken by the government. The specialists of the IMF claim the measures are really effective and there is no need to amend them, despite the current economic downturn on the local market. The monetary and fiscal policies of the Bank of England look satisfying for the IMF and according to their opinion the adoption of the low interest rates is a really smart step that will help to pay the debts off and stimulate the economy.
But there is a serious risk of high inflation that may result in the unstable currency rates and may have a negative impact on the economy mechanisms. Therefore the need in the regulation and close government control over this situation is required because it is the only way for the inflation rate to be managed and the economic growth to be supported.
Conclusion
The policymakers attach considerable importance to identifying symptoms of financial crises ahead of time. And since crises can quickly spread between countries, knowledge of the ways in which financial distress is transmitted across borders also becomes important since it allows policymakers to anticipate possible “second round” casualties of crisis. (Chui and Gai, 2005)
Overall, the UK government efforts may be estimated as non extraordinary or brilliant but as the relevant ones.
Two elements of the macroeconomic policies presented by UK authorities include the monetary and fiscal policies. They seem to be able to deal with the shocks presented by the recent economic and financial crises and are designed to fight with their negative consequences. Both monetary policy and fiscal policies slowly but confidently fight the recession and will initially lead to recovery.
Despite the fact that the situation on the UK market is not the healthy one at the moment, there are some positive signs of the future recovery claimed by the journalists and financial analytics. Another important factor that may influence the UK’s recovery is the situation on the EU markets because of the close connection between these countries.
