Essay on Analyse the mechanisms and briefly evaluate the effectiveness of macroeconomic policy measures introduced by the UK
The global credit crisis that started in 2007 and revolutionized into the economic recession in 2008 is seen as the worst since the Great Depression of the 1930s. Globally reduced access to credit, higher loan rates, falling of asset prices and economic growth rates weakening have all been related to the so called ‘credit crunch’. The United Kingdom as a residence for some of the core financial markets in the world was especially affected by the crisis.
In 2008 the situation took a turn for the worse as credits desisted, confidence declined, the value of pensions and savings sharply fell and the demand reduced when many enterprises cut expenses and increased levels of savings. It resulted into hard market stress and provoked possibilities for further failures.
The UK government had to react quickly and to suggest an array of measures to cope with the crisis. The anti-crisis program of UK government had to enhance the solvency, liquidity and funding of financial institutions. The government’s measures were directed to restoring banks contributions into the economy and recovering financial stability, assisting financial institutions in maintaining their access to wholesale funding; measures on purchasing of impaired legacy assets were directed to assisting banks in reducing possible large losses.
Andreas Busch (2008) comments on the UK government £500 billion program started in order to stabilize the banking system. It included bank recapitalization, credit guarantees, (partial) state ownership of several banks, deposit guarantees and exchange of illiquid assets with the Bank of England. The United Kingdom has spent more than 50% of its 2008 GDP (Bank for International Settlements, 2009). The International Monetary Fund states that the UK spent about 81.8% of GDP on financial sector assistance in 2008 (IMF, 2009). The UK government insisted on £50 billion Bank Recapitalization Fund to assist eligible banks in strengthening their capital ratios. Credit Guarantee Scheme (up to £250 billion) had to unblock the interbank money market to provide banks with a guaranteed source of financing and to improve the flow of credit into state economy. The Bank of England’s Special Liquidity Scheme of £200 billion permitted financial institutions to exchange preexisting illiquid assets for Treasury bills within a three-year period (Busch, 2008). The Asset Protection Scheme offered protection of banks against potential losses on certain assets in exchange for a fee. It allowed them to resume making loans to creditworthy businesses and households. Highly aggressive monetary policy was established by the Bank of England. The bank reduced its interest rate from 5% in October 2008 to 0.5 % in March 2009 and continued constant cutting the interest rate in the first quarter 2009. It led to the so called ‘liquidity trap’ which means that the monetary policy is totally ineffective as no further cut of interest rate is possible. Thus, in March 2009 the Bank and the Treasury agreed about quantitative easing which is often taken as the “last resort” to support the economy (Hadson and Mabbett, 2009). The fiscal policy of the UK under crisis is characterized by a massive growth of borrowing ‘with the government’s net cash requirement soaring from 2.3% of GDP in 2007–08 to 11.5% in 2008–09’(Hadson and Mabbett, 2009). The government also launched discretionary fiscal measures including assistance for private investment, household consumption, public investment and labour market adjustment. ‘Tax cuts account (Crossley, Low and Wakefield, 2009) for an estimated 73 percent of the £ 20 billion fiscal stimulus package, with the principal mechanism a temporary cut in the rate of Value Added Tax (VAT), from 17.5 percent to 15 percent, for a 13-month period from 1 December 2008 until 31 December 2009. In order to support household consumption the government has announced a reduction in the personal income tax allowance for people with incomes over £100,000 from April 2010.’ To improve active labour market policies, the UK government prepared the white paper on employment, “Building Britain’s Recovery: Achieving Full Employment.” In 2009 an estimated £5 billion was spent on employment-related measures.’ The government concentrated on the provision of loans or loan guarantees to small and medium enterprises (SMEs) to assist businesses and venture capital (Davies, Kah and Woods, 2010). Another important measure was support for exporting. The taxation of foreign profits cut as well as more liberal tax relief for unprofitable businesses were introduced. £3 billion of capital was also spent on infrastructure support. National investment assstance was concentrated on schools, motorways, social housing and effective use of energy.’ In addition, alcohol and tobacco duties were increased, while fuel duties grew to about 2 pence per liter December 1, 2008. In April 2011, national insurance contribution rates for employees, employers and the self-employed is planned to increased by 0.5 percent. Moreover, in April 2011 another higher income tax rate of 45 percent for those whose incomes are above £150,000 was introduced.
The collected data and observation of recent research and publications show that not all the anti-crisis measures suggested by the UK government were reasonable and effective.
The Bank of England’s quick constant cuts of interest rates confirms the fact that it was not necessary to undertake monetary easing because of inflation problem. In 2009 there was no guarantee that borrowers would indeed benefit from lower interest rates (Sentence 2009); now it is clear that lower borrowing costs are received by companies and households. In this case aggressive monetary policy of cutting interest rates for reviving the economy was insufficient (Hadson and Mabbett, 2009).
Quantitative easing was considered to be a radical but a rational step for stabilizing the situation. According to Deputy Governor for Monetary Policy at the Bank of England Charles Bean, positive aspects of quantitative easing can be seen: investment-grade corporate bond yields have fallen by almost 4 %, equity prices have restored half their losses and capital market issuance has been unusually high, nominal demand growth was regained to an annual rate of around 4% (Bean 2010). Some other specialists admitted the weakness in bank loans and argued the fact that quantitative easing was not effective. While the essential increase in bank deposits and bank funds as a result of the asset purchase program could indeed embolden banks to extend more credit.
In fact, some businesses were not able to access capitals through the capital markets. Thus, the right measure was to allow banks to lend normally again as soon as possible. The measures introduced by the UK Government to provide assistance to the banking system, although extremely costly, effectively solved the difficulties with obtaining loans and stabilized financial institutions functioning.
Inflation had fallen as low as 1% September 2009. Since then, it has increased to 3.5% in January 2010. Deputy Governor for Monetary Policy clarified ‘that volatility in inflation can be explained in terms of a variety of factors impacting on the price level (Bean 2010). Thus, inflation, owning to a variety of measures, has remained stable and reasonably well anchored.
Discretionary decisions to cut taxes or increase spending had not contributed much in stimulating fiscal deficit in the UK (Hodson and Mabbett, 2009).
The fact that more than half of fiscal stimulus was spent on household consumption financial support demonstrates that government had to suspend its fiscal rules.
The UK government decisions about temporary cut of the VAT, loans to SMEs and sectorial support of industries were effective and led to boosting business confidence. Though the government undertook the multifaceted strategy to support labor sector, it has only managed to slow down but not to decrease the unemployment rate during the crisis period. Under the circumstances assistance for public investment had the least priority among the suggested measures. The main step was energy efficiency and low-carbon industry. Jim Brumby and Marijn Verhoeven support this fact (Brumby and Verhoeven, 2010).
Thus, the detailed analysis of the UK government macroeconomic policy measures in response to the global credit crisis reveals both effective and ineffective strategies. First of all, it is necessary to reinforce the UK monetary policy with much closer control and analysis of the financial sector and its influence on the activities of enterprises. Besides, more attention should have been paid to the state and development of the financial sector. The increasing integration of the global economy should be acknowledged, with the fact that an open to international trade economy like the UK one is exposed to global economic shocks. Thus, more effective international co-operation is needed. Another delusion lays in the point of view that monetary policy like the control of the money supply and setting of interest rates can always stabilise economies in critical situation.
The third lesson should be connected to revising the in the face of a wide range of shocks. Labour market was supported by launching active labour market policies aimed at assisting unemployed people or workers at risk of losing their jobs. The government also cut social security support. A Small Business Finance Scheme was the way to implement private investment. The main focus of public investment funding was social infrastructure development, renewable energy and energy efficiency. Duties on alcohol and tobacco and fuel had to be increased to support the discretionary stimulus package.
The tax policy had been reconsidered and the rates were increased. The monetary policy played the core role in managing the crisis; however the average size of the UK discretionary fiscal measures in 2009-2010 was higher than that both in the EU and in the USA.
The combination of the aggressive monetary policy and discretionary fiscal stimulus helped to overcome a deep recession, resotore major markets and stabilize economic growth in the United Kingdom.
