The Main Monetary and Fiscal Policy Instruments Available to the British Government - Essay Example

?Explain the Main Monetary and Fiscal Policy Instruments Available to the British Government and Examine the Relative Importance that is Attached to them by this, and by Previous Governments of the Post-war Era The British economy likewise any country’s economy is governed by micro-economic and macro-economic policies of the government. These are the monetary and fiscal policy instruments at macro level, the essential components of the UK government economic policies. The government policies are constructed and designed by relevant government departments such as the Treasury, officiated by the Chancellor of the Exchequer; the Department for Work and Pensions (DWP), the Department for Children Schools and Families (DCFS), and the Department for Business, Enterprise and Regulatory Reform (BERR). These are the major monetary and fiscal policy tools to run the economy in the hands of the government. The UK government wants to gain macroeconomic stability via its fiscal policy, which is made to aid the monetary policy in ‘smoothing the path of aggregate demand over the economic cycle’ and in providing long term growth and curb over inflation. This is the leading macroeconomic aim of fiscal policy, which can be attained through normal government spending in actuality, concurrent government spending and social security benefits awarded by the government (Riley, “Fiscal Policy,” par. 10). Fiscal policy is one of the crucial instruments under which the government manages its spending, taxation and borrowing; they are the leading fixers to give direction to the economy through fiscal policy. The power of the fiscal policy can mold the economic activity and ranks of aggregate demand, employment and manufacturing. A spur in government expenditure or decrease in taxes brings an increase in aggregate demand and boosts employment. The extent of the transformation brought about by national income equilibrium is attained because of the multiplier effect. If the multiplier is greater its impact on the economy would be huge as shown through the national income (Riley, “Fiscal Policy,” par. 3-5). In the UK, consecutive governments have taken the task of bettering the performance levels of the public sector services by using on a large scale the trend of contracting and competitive tendering so that services improve through competition between the private and public sector in such areas as NHS catering, laundry and cleaning services along with infrastructure development and correction services. The government has initiated such schemes as value for money for its departments by setting performance parameters in increased numbers (Riley, “Fiscal Policy,” par. 7). Demand and Supply-side Policy Demand and supply side policies are government tools that help it to achieve policy aims. The demand side policies of the UK government are: 1. Fiscal policy—it is related to levying of taxes and government outlays. 2. Monetary policy—it governs issues like rate of interest and flow of money. 3. Exchange rate policy—it involves shuffling in the rate of Sterling Pound. Supply-side Policies 1. Help the government in boosting competition and performance in product markets. 2. Help in increasing of competition and production in factor markets, particularly labour markets. 3. Help in boosting the domestic savings by offering incentives. 4. Offer attractive schemes to firms for increased production and investment (Economics Online, “Fiscal Policy,” par. 6). Fiscal Policy It is the planned attempts to change the government outlay or taxation to gain desired macroeconomic results by manipulation in aggregate demand. There are two classes of fiscal policies, discretionary and automatic. 1. Discretionary policy. It is related to such policies that are formulated and enforced by one-off policy changes. 2. Automatic policy helps in stabilizing the economy by fiscal drag and fiscal boost (Economics Online par. 1). Fiscal Drag It diminishes the effect of increased income for goods as taxes are levied in increased ratios. Progressive direct taxes are charged on a percentage of income, which diminishes the rate at which income increases at national level (Economics Online, “Fiscal Policy,” par. 2). Fiscal Boost It puts a limit on the ongoing uninterrupted downturn in national income. It means when recession brings down the income level, its impact is minimised by imposing taxes such a way that flow of income is obstructed to the desired limit after taxes are deducted (Economics Online, “Fiscal Policy,” par. 3). In the same design a severe downfall in national income could be obstructed by fiscal boost. By fiscal boost, the government attempts to subdue the effect of falling income during economic downturn by reducing the taxes proportionately and keeping the bulk of the after-tax income with it (Economics Online, “Fiscal Policy,” par. 4). Fiscal boost controls the impact of economic downturn by withholding total fall in the income of unemployed and the poor by awarding benefits to them so that spending level is partially maintained, which could not have been possible in the absence of awarded benefits by the government. Therefore, the affect of the recession also gets reduced (Economics Online, “Fiscal Policy,” par. 5). Government Expenditure Government outlay in public sector can also be a macroeconomic instrument at the disposal for the policy makers at different state and central levels such as: 1. Government can supply certain goods and services, which are beyond the capacity of the private sector in certain areas as defence, development of infrastructure including merit constructions like schools and hospitals, payments pertaining to welfare services and benefits provided on the front of unemployment and disability. 2. Government can gain through supply-side measures by disbursing on education and training to better labour output. 3. By making additional money inflow in the economy for realizing increase in aggregate demand and economic activity. 4. By subsiding external affects like fixing pollution levels. 5. By offering subsidy to industries which was not otherwise possible through personal efforts. 6. By revising distribution of income to attain better equity (Economics Online, “Fiscal Policy,” par. 6). Monetary policy of the government can help in controlling inflation via changing of interest rates while through fiscal policy the government strives to change as per government needs the level of economic activity. The main purpose of the government through fiscal policy is to minimise inflation CPI=2%, achieve robust economic progress without any slip in the drive in the long term on inflationary growth, downfall in the level of unemployment and delaying of large deficit on current account balance of payments (Economics Help, “Monetary and Fiscal Policy in the UK,” par. 1). The Bank of England The Bank of England is an independent organisation and major tool of the British government. The main aim of BoE is preparation of the monetary policy of Britain. The Bank functions through the nine-member Monetary Policy Committee (MPC) headed by the Governor of the BoE. It is sole responsibility of the MPC to take all decisions related to the Bank (Economics Online, “Monetary Policy,” par. 4). The BoE is one of the leading central banks in the world. It was constituted in 1694 and nationalized after the Second World War. It is the primary function of the BoE to formulise the monetary policy of Britain along with managing the national reserves and strong functioning of the banking systems. The purpose of BoE is to regulate prices, money supply and flow, function as government banker by supporting government policies, work as banker of last resort for other banks and see to realising of banking controls and supervising (Economy Watch, “UK Economy,” par. 1). Gordon Brown, the Chancellor of the Exchequer in 1997 enhanced the powers of the bank in fixing interest rates, which were earlier decided by the Chancellor. In the year 2009, the BoE decreased interest rates to 1.0% while there were rumors that the decrease in interest rate would be 0.5% (Economy Watch, “UK Economy,” par. 4). The UK followed the ‘Golden rule’ in fiscal policy as Gordon Brown wanted the borrowing for investing purpose only. Emerging needs were met via taxes. Other than the Golden Rule, the UK government follows the Sustainable Investment Rule for not permitting the national debt to crossover 40% of GDP. In the year 2008, it could not be maintained as the national debt went above 42%, expecting to reach 70% by 2010 with the justification that to control recession, the economy required the Keynesian stimulant (Economy Watch, “UK Economy,” par. 6-8). The Treasury, the Chancellor, and the Prime Minister The Treasury is the UK government’s major economic policymaking department. Generally, the Chancellor of the Exchequer is the head of the Treasury. His or her official rank, the Second Lord of The Treasury, exhibits that historically and legally the Prime Minister is the authorised and first head thus, the First Lord of the Treasury (Economics Online, “Macroeconomic Policy,” par. 2). The Budget The budget is presented in two installments, the first installment in the autumn statement; it is also called as the pre-budget report, which shows expected outlays and is presented in November every year. The second installment is the budget statement; it is made in April and provides detail of the tax changes for the next financial (fiscal) year. The budget statement also states the government’s perspective on the would-be reaction of fiscal policy for the next year in terms of whether the budget would be expansionary, shrinking or neutral (Economics Online, “Macroeconomic Policy,” par. 3). The Inflation Report It is introduced by the Bank on quarterly basis with the objective of framing the actions of the MPC and collaborating information with the public and other particular parties. The Bank has been publishing the Inflation Report since 1993, working to the below-mentioned fields of interest such as: 1) Money and asset costs 2) Demand situations 3) Supply circumstances 4) Costs and prices and 5) The future considerations on inflation (Economics Online, “Macroeconomic Policy,” par. 6). Fiscal policy also impresses the supply side output of the economy via government spending, which includes general government spending, final consumption and transfer payments. The aims of government expenditure and fiscal policy are as figured out by the Treasury, are related to equity issues, funding government expenditure, the benefit principle and macroeconomic endurance (Riley, “Fiscal Policy,” par. 2). The new fiscal policy of the UK government can be decisive to the UK private equity industry if the new conservative government enforces the proposal of doubling the capital gains tax. Previously, the rate of CGT was altered in 2007 by the Labour Party government from 10% to 17%, which could reach to 40% causing exit of industries to secure places. Earlier increase in CGT caused huge cut in income from ?5.3bn (€6.22bn) in 2007/2008 to ?2.5bn (€2.93bn) in 2009/2010 (Alt Assets par. 1-4). In the post war period, economists and policy makers walked on Keynes’ wider framework of traditional ‘consensual’ outlook associated with the instability of the capitalist economy wherein the role of aggregate demand stipulates the standard of economic activity on the condition that lack of economic forces lead to full employment. Keynes himself found relevance of Keynesianism with fiscal policy leading too far to put a fence on it. It indicated controls on using monetary policy besides the government spending making the fiscal policy tools stronger than they were before 1939. Comparatively the monetary policy had been serving to deflationary aims in sync with the 1920s when loyalty to gold standard was taken as support for active monetary policy, the fiscal policy was central in following the Keynesianism (Clift & Tomlinson 6-9). An active fiscal policy increases the chances of deficit budgeting which is central to Keynesianism; it is still a trend of the British government to boost the morale of the money markets by not indulging in grand scale fiscal surpluses. Under the New Labour government, the fiscal policy plays a passive role in changing the budget deficit position over a business cycle but it should not mean that the New Labour government has terminated the active fiscal policy in principle; it has been ‘coarse-tuning’ the fiscal policy to get positive vibes. The New Labour does not deny a desired rate of unemployment, delinking any correlation between inflation and unemployment, which shows that in macroeconomic policy no setting in aggregate and effective demand is possible (Clift & Tomlinson 9-13). The concept of interplay between supply and demand sides and their relation with unemployment can be clearly seen in the New Labour government. The need for interaction between both microeconomic and macroeconomic policies is needed for growth, stability and employment. Supply-side issues are important but demand jerks are risky. The New Labour government is more nearer to Keynesian in identifying that demand alone cannot ensure stability in employment, a crucial feature of New Labour’s political economy (Clift & Tomlinson 15). One thing is clear that policies of the New Labour government have not promoted competitiveness. It is significant to note that the New Labour government has not faced a test of its macro economic policies in recession time although Britain’s macro economic policies have reduced the tremors felt by France and Germany in 2002-03. Works Cited Alt Assets. New UK Government’s Fiscal Policy Threatens Future of PE. 2010. Alt Assets. 27 April 2011 . Clift, Ben., Tomlinson, Jim. “Credible Keynesianism? New Labour Macroeconomic Policy and the Political Economy of Coarse Tuning.” The British Journal of Political Science (2006): 36. Economics Help. Monetary and Fiscal Policy in the UK. 2007. Economics Help. 27 April 2011 < http://www.economicshelp.org/blog/uk-economy/monetary-and-fiscal-policy-in-the-uk/>. Economics Online. Fiscal Policy. 2011. Economics Online. 27 April 2011 . Economics Online. Macro-economic Policy -- Policy Makers. 2011. Economics Online. 27 April 2011 < http://www.economicsonline.co.uk/Managing_the_economy/Policy_instruments.html>. Economics Online. Monetary Policy. 2011. Economics Online. 27 April 2011 . Economy Watch. UK Economy: The Bank of England, UK Monetary and Fiscal policy. 2011. Economy Watch. 27 April 2011 . Riley, Geoff. Fiscal Policy. 2006. Eton College. 27 April 2011 . Read More