Fiscal And Monetary Policies Possible TO Boost Economy Of UK

FISCAL AND MONETARY POLICIES POSSIBLE TO BOOST ECONOMY OF UK

Fiscal and Monetary Policies Possible TO Boost Economy of UK

Student’s Name

Professor’s Name

City/State

Course

Date

Fiscal and Monetary Policies Possible to Boost Economy of UK

Introduction

Since 1997, economies of several countries in the world like the UK have faced

macroeconomic problems such as oil shocks. Such problems contributed to an intensification

of inflation and deflation bringing about instability in the world’s economies (Fernández,

2015, 36). This situation drew the attention of the world, and countries decided to invest more

in research to provide remedies to the problem. Several theories were developed, and the

most important one was the effective application of fiscal and monetary policies. This work

discusses into details the fiscal policies and monetary policies which can be applied in the

UK to boost their economic growth.

Fiscal Policies Applicabe in the UK to Boost Economic Growth

Fiscal policies refer to the manipulation of government taxations and expenditure to the

public with the central aim of changing aggregate supply and aggregate demand (AS/AD) in

a way that achieves macroeconomic goals like price stability, full employment, and improved

gross domestic product (GDP) (Dosi, 2015, 166). Fiscal policies are of two board category,

expansionary policies, and deflationary policies.

Case 1: if the economy of UK is experiencing depression, expansionary fiscal policies are

applicable. As consequence, the country would be able to increase the aggregate demand in

the economy. Typically, the government of UK can achieve this by imposing tax cuts

whereby the government reduces the amount of taxes levied on the public to increase the

personal disposable income which, in turn, increases the value of induced consumption (Dosi,

2015, 169). This is as shown by the equation of consumption (C=a + bY). The part of the

equation, bY is the value of consumption which depends on level of income.

The United Kingdom can also apply the other inflationary fiscal policy that entails rising

government expenditure programs. Typically, the government can alternatively increase its

spending to the public aiming at increasing the money supply in the economy. Again if the

government will spend a lot on the projects which creates jobs to the public, it will, at lon-

run, generate income to the public and this, in turn, will increase the amount of disposable

income (Fernández, 2015, 36). It is noted that for normal goods, as income increases, the

demand for goods and services increases (Dosi, 2015, 175). Additionally, it is good to note

that for full employment the economy must accept certain level of inflation (Ćorić, et. Al.,

2015, 410) For instance, given the information that a person with no income will not be able

to purchase any TV, however, if he starts earning $10,000, he will demand 2 TVs, at

$20,000, the demand increases to 4. This information is illustrated in table and graph below.

Income

Quantity demanded

Yo=$0.0

Qo=0

Y=$10,0000

Q=2

Y1=$20,000

Q1=4

From the graph above, it is vivid that as income increases the demand for normal goods also

increases. This implies that the UK government will achieve increased aggregate demand by

reducing the taxes on personal income and more spending to the public.

Case 2: the economy may be experiencing inflation, and according to Keynes suggestion that

there is a need for discretionary policies, the government of UK is supposed to intervene to

curbing the problem. It can only achieve this through the application of deflationary policies.

These are the opposite of the inflationary policies. Deflationary policies are also referred to as

contractionary fiscal policies (Ćorić, et. Al., 2015, 415). They aim at reducing the demand in

the economy which brings about inflation in the economy. They include, increase in taxes;

government can reduce the money supply in the economy by increasing the percentage of

personal income tax (Seidman, 2015, 1). This means that the value of induced consumption

which is a function of income (bY) reduces (Dosi, 2015, 187).

The second deflationary policy is reducing government spending; this involves reducing

government spending on the public to reduce the money supply in the economy. UK

government should employ this strategy by reducing the programs which generates income to

the public, money circulating in the economy will reduce. For the case of normal goods,

when income reduces, the demand also reduces (directly proportional) (Ćorić, et. Al., 2015,

419). This means that generally fiscal policies in the UK involves entirely the UK

government intervention to affect the total demand and supply in a way that achieves its

economic goals (Fernández, 2015, 36).

Monetary Policies Applied in the UK to Boost Economic Growth

These are actions taken by the central bank with the aid of other commercial banks and all

financial institutions to affect the total supply and total demand in the economy in a manner

that it achieves economic objectives like full employment, stabilized prices, required inflation

for full employment, and finally economic growth (Seidman, 2015, 1). The central bank of

UK should apply five major monetary tools which include, bank reserves, discount rates,

open market operations, legal reserve requirements, and bank rates (Ćorić, et. Al., 2015, 421).

The policies are applied according to the economic situation. This means if the UK economy

is experienced deflation the tools should be applied in a way to increase money circulation in

the economy (Wyplosz, 2014, 498).

Case1: during deflation, when the UK economy is facing inflation like the case of financial

crises in 2008 and 2009, the central bank should apply tools like, cut in bank rates, during

this time the bank of UK is supposed to reduce bank rates. For instance, in 2008 and 2009,

the bank reduced the bank rates by 4.5%. This action allows more borrowing by the public

instead of saving. This is because savings decreases with decreasing bank rates. Since saving

is a function of income (S=sY), more borrowing with fewer savings will increase the money

supply in the economy (Fernández, 2015, 36). The increase in the amount of money

circulating in the economy increases aggregate demand for goods and services. All this, in

turn, raised the GDP of the country. The figure below illustrates the relationship between

savings and income level

Figure 1Relationship between Income and Saving

From the figure above the individual will only start saving when the level of income is at (Y)

below that he will instead be dissaving, the slope of the curve gives the propensity to save.

Reduction of discount rates; during the economic depression, the bank of UK can reduce

discount rates. These are charges to financial institutions by the central bank for discounting

financial equivalents like treasury bills and promissory notes (Seidman, 2015, 1). This

encourages financial institutions to discount the treasury bills even before maturity. The

action helps in increasing liquid cash to the economy thus increasing aggregate demand in the

economy. This is because as the income increases, the demand for goods and services

increases.

Open market operations, this refers to buying and selling of securities. During the economic

depression, the bank of UK should buy securities from the public and give cash to them

(Wyplosz, 2014, 498). This brings about an increase in money supply in the economy and

thus increasing demand. Increased demand calls for more production of goods and services,

and therefore many people are absorbed in production thus whereby the problem of

unemployment is said to have been solved. Additionally, the act also will solve the problem

of deflation and bring prices back to the equilibrium (Nakata, 2016 222).

Bank reserves, these are also referred to as cash backing, they are the deposits held by the

bank. This calls for financial institutions to have a minimum amount with the central bank.

This increases the money to lent to the public (Wyplosz, 2014, 498). This aids in the

reduction of interest rates and more borrowing thus high investments. Through this the UK

government will have solved the problem of unemployment, output, and price.

Legal reserves, these refer to the cash requirement by financial institutions against savings

and other deposits. When the economy of the UK is at its depression, financial institutions

should reduce their legal reserves (Wyplosz, 2014, 498). This implies that the public can

withdraw as much money as possible leaving the very little amount in the bank as reserves. If

this is the case, the money supply in the economy will increase and therefore increase in

aggregate demand in the economy resulting in high production of goods and services. This

will raise the GDP, and in the process, employment will be enhanced, prices are brought back

to equilibrium.

Case 2: when the economy is experiencing inflation, this is whereby in the economy, a lot of

money chases few goods and services. During this situation, the central bank of UK should

use tools like increasing bank rates; this implies that the investments will be reduced. This is

because the investment and interest rates are inversely proportional (Fernández, 2015, 36).

Low investments result in low capital formation and therefore reduced money supply in the

economy (Chamberlin, 2015, 18). This will reduce aggregate demand in the economy low

demand will result to low prices of commodities. This means that the equilibrium price will

be restored. Inflation, on the other hand, will be reduced to a level sufficient for full

employment (Goodwin, et. Al., 2015, 1).

Selling of securities, bank of UK should sell securities to the public during the period of

inflation in the economy. This implies that the public will hold securities and not liquid cash.

This brings about reduction in money supply in the economy (Nakata, 2016 222). As a result

of the reduction in money supply, the aggregate demand for goods and services will reduce

and prices will reduce towards equilibrium level (Jawadi, et. Al.,2016), 536. The public will

hold the securities until their value increases. The process will stabilize prices, create

employment and increase GDP thus economic growth (Chamberlin, 2015, 24).

Increasing legal reserves, this will increase the amount of money held by financial

institutions against deposits. The institutions will do this to ensure that the money supply in

the economy is reduced and thus low demand (Jawadi, et. Al.,2016, 537). This implies that

the prices will fall towards the equilibrium level. The action by financial institutions helps in

restoring the stability in prices and lowering the inflation to the required level sufficient for

full employment in the economy (Jawadi, et. Al.,2016, 539). The economy experiencing full

employment will produce to the capacity (Nakata, 2016 222). This increases the GDP of the

UK.

Increasing discount rates, this will discourage financial institutions from discounting

treasury bills. The practice will reduce money circulation in the economy (Jawadi, et.

Al.,2016, 540). Reduced money supply means low demand for goods and services (Wyplosz,

2014, 498). Low demand implies low prices, and as a result, stable economy is attained for

optimal production, full employment, and stable prices. The last point is increasing bank

reserves; this will reduce the amount of money available in the financial institutions for

lending (Wyplosz, 2014, 498). As a result, the money supply goes down, and aggregate

demand will reduce due to low purchasing power (Sobrun, et. Al., 2015, 1). This will result in

low prices, low inflation, and full employment (Palley, 2015 1).

It is worth to understand that while fiscal policies are being applied or monetary tools, there

other practices which can be applied in the economy (Palley, 2015). Therefore, the points

discussed above will be applied under the condition that is all other factors should be held

constant. There are some challenges which can be experienced especially if UK is will apply

monetary policies.

The drawbacks include but not limited to, liquidity trap; this is a situation whereby economic

activities are encouraged through the lowering of interest rates. This situation may bring

abought lack of confidence the bank and thus bank financial crisis (Palley, 2015 2). The

effect of changing rates on exchange rates. If monetary tools are tight, this brings about

appreciation of the value of exchange rates and may make exports of UK to be less

competitive (Bell, et. Al., 2015,200). This is said to affect the countries balance of payment

(Palley, 2015, 4). The other challenge is time lags that is, the bank may alter its base rates but

will take some time for the results to be seen in the economy (Williams, 2015, 1).

Conclusion

Due to macroeconomic problems experienced in the 1970s and 1980s, there were theories

advanced to provide remedies to such problems. Policies and goals were among the theories,

and the policies applied especially in the UK are fiscal and monetary policies. Fiscal policies

refer to the adjustments made on government taxation and its expenditure considering the

economic situation at the time. These adjustments aim at affecting aggregate supply and

demand in a way to achieve the objectives of the economy. The government of the UK can

reduce taxes and increases its expenditure during the time of deflation in the economy. It can

increase taxes and reduces its expenditure during inflation.

Monetary policies are the actions of the central bank to affect the demand and supply to

achieve economic objectives. They involve adjustments of the bank rates, legal reserves,

bank reserves, and discount rates during inflation all the above tools are expanded, and during

deflation, they are contracted. All these policies are applied when other factors are held

constant. There are several challenges like a liquidity trap and time lags.

List of References

Dosi, G., Fagiolo, G., Napoletano, M., Roventini, A. and Treibich, T., 2015. Fiscal and

monetary policies in complex evolving economies. Journal of Economic Dynamics

and Control, 52, pp.166-189.

Wyplosz, C., 2014. Europe’s quest for fiscal discipline (No. 498). Directorate General

Economic and Financial Affairs (DG ECFIN), European Commission.

Fernández-Villaverde, J., 2015. Fiscal policy in a model with financial frictions. American

Economic Review, 100(2), pp.35-40.

Nakata, T., 2016. Optimal fiscal and monetary policy with occasionally binding zero bound

constraints. Journal of Economic Dynamics and control, 73, pp.220-240.

Palley, T.I., 2015. Money, fiscal policy, and interest rates: A critique of Modern Monetary

Theory. Review of Political Economy, 27(1), pp.1-23.

Seidman, L.S., 2015. Automatic fiscal policies to combat recessions. Routledge.

Jawadi, F., Mallick, S.K. and Sousa, R.M., 2016. Fiscal and monetary policies in the BRICS:

A panel VAR approach. Economic Modelling, 58, pp.535-542.

Ćorić, T., Šimović, H. and Deskar-Škrbić, M., 2015. Monetary and fiscal policy mix in a

small open economy: the case of Croatia. Economic research-Ekonomska

istraživanja, 28(1), pp.407-421.

Chamberlin, G., 2015. Coordinating monetary and fiscal policies in an open

economy. International Economics Letters, 4(1), pp.15-25.

Sobrun, J. and Turner, P., 2015. Bond markets and monetary policy dilemmas for the

emerging markets.

Bell, D.N. and Eiser, D., 2015. Migration and fiscal policy as factors explaining the labor-

market resilience of UK regions to the Great Recession. Cambridge Journal of

Regions, Economy, and Society, 9(1), pp.197-215.

Goodwin, N., Harris, J.M., Nelson, J.A., Roach, B., and Torras, M., 2015. Macroeconomics

in context. Routledge.

Ricci-Risquete, A. and Ramajo-Hernández, J., 2015. Macroeconomic effects of fiscal policy

in the European Union: a GVAR model. Empirical Economics, 48(4), pp.1587-1617.

Ezejiofor, R.A., Adigwe, P.K. and Echekoba, F.N., 2015. Tax as a Fiscal Policy and

Manufacturing Company’s Performance as an Engine for Economic Growth in

Nigeria. European Journal of Business, Economics and Accountancy, 3(3), pp.1-12.

Williams, J.C., 2015. Monetary policy at the zero lower bound: Putting theory into

practice. Hutchins Center Working Papers.

Place new order. It's free, fast and safe

Paper type

Deadline

Page count

550 words

Total price: $ 15.00

Our customers say

Jeff Curtis

USA, Student

"I'm fully satisfied with the essay I've just received. When I read it, I felt like it was exactly what I wanted to say, but couldn’t find the necessary words. Thank you!"

Ian McGregor

UK, Student

"I don’t know what I would do without your assistance! With your help, I met my deadline just in time and the work was very professional. I will be back in several days with another assignment!"

Shannon Williams

Canada, Student

"It was the perfect experience! I enjoyed working with my writer, he delivered my work on time and followed all the guidelines about the referencing and contents."