UK Government Controls the Economy - Example

UK Government Controls the Economy Introduction Government of a nation is en d with a number of responsibilities and maintaining the well-being of the country and insulating it from external shocks are two of the most preliminary functions. It also ensures that the growth of the country does not stagnate and takes measure to ensure that the economy can attain maximum level of growth. Fiscal and Monetary policy are the two most important tools that are used by the governments and policy makers to stimulate the economic growth of a nation (Mankiw, 2014). These policies have the potential to fuel the domestic demand in the economy which in turn affects growth. This paper analyzes three of the most important functions performed by the U.K. government namely the monetary policy, fiscal policy and the unemployment policies undertaken. These are three of the most important macroeconomic indicators that can be used to interpret the overall performance of the economy. This will help in determining the way in which the government of the country controls the economy. U.K. Economic Overview The U.K. is undoubtedly one of the strongest countries of the European Union. It is a leading financial centre and is considered as one of the most important developed countries in the global economy. The country is also a part of international organizations like the United Nation, European Union, World Trade Organization and the International Monetary Fund (CIA, 2014). Agriculture and service sector of the country are the strongest drivers of economic growth at present. The agricultural sector of the country is highly capital intensive and is efficient enough to meet 60% of the food requirements. However, it employs less than 2% of the labour force (CIA, 2014). The share of service sector in the GDP is very high as banking, financial services and business enterprises are main performers in the economy. Figure 1: GDP growth of the UK (Source: The World Bank, 2015) The annual growth percentage of GDP has been shown in the above graph. The average rate of growth of the U.K. economy was 3% from 2000-2007 reaching a peak of 4% in 2003. However, the global economic crisis of 2008 had a drastic impact on the U.K. economy and the negative growth rates were recorded in 2008 and 2009. The government of the country has taken a number of measures to restore the economic growth after the crisis of 2008. For instance, the government has taken a number of austerity programs to reduce the government deficit in order to stabilize the economy. Other measures are reduction of corporation taxes to encourage business activities, controlling the interest rates and constraining the welfare policies of the government. Three main policies are the topic of discussion in this paper: monetary policy, fiscal policy and trade policy. The role of the government of the UK Monetary policy The government of the U.K. regulates the monetary policy of the country through the Bank of England. No sooner did the impact of the crisis begin to weaken the economy than the Bank of England sprang into legitimate action. The Bank of England like most other central banks had reduced the interest rates in order to boost the investments in the country. The Central Bank had followed expansionary monetary policy mainly by purchasing assets from the government (Joyce, Tong and Woods, 2011). This policy was termed as quantitative easing. This was done in line with the inflation target of the economy. The Bank of England wanted to boost the domestic demand of the country by influencing domestic spending. Economists have pointed out the use of purchase of assets affects both the government spending and inflation (Joyce, Tong and Woods, 2011). The Bank of England purchased the assets in order to improve the supply of broad money, raise the price of assets, increase the level of public spending and reduce the cost of borrowing. The Central Bank had also focused on the policy of forward guidance to cheer up the economy (Bank of England, 2014). It is a policy in which the government agrees to keep the interest rates at a consistent low level even after the economy reaches full level of employment and output. Following this type of a policy is rather unconventional because under normal circumstances the central bank chooses to raise the level of interest rate just before the output and employment levels reach their equilibrium value (Mishkin, 2007). However, the weak economic situation in the country forced the bank to keep the interest rate at the lowest possible level. This was done with the incentive of providing confidence to the investors. During the recessionary policy, the government had agreed to keep the interest rates at the lowest possible rate of 0.5% (Bank of England, 2014). Following this type of a monetary policy has its own share of shortcomings, the most important one being the rise in the level of inflation in an attempt to boost domestic demand. The Bank of England has been successful in raising the overall growth rate of the economic growth by following this policy. There is no denying the fact that the government has been able to influence the level of overall unemployment and output growth by following these policies. Fiscal policy The government of the U.K. like most other developed countries had embarked upon a mission to improve the economic situation when the economy was in recession. Two major policy prescriptions were followed by the government namely an increase in the public spending and a cut in the corporate taxes. Macroeconomists asserts that increasing the level of government spending can create a larger demand for goods and services. The rise in income as a result of this policy reinforces the spending power of the public which is a good sign during periods of economic recession (Blanchard, et al., 2012). There is a growing stance among researchers that the use of complementary monetary policy is a crucial factor under this type of a fiscal policy. This is because if the central bank of the country begins to raise the rate of interest on borrowing then it actually crowds out the positive impacts of an expansionary fiscal stimulus (Carbaugh, 2013). Another conventional measure is the reduction of rates of tax. The rationale behind doing this is to increase the level of domestic income of the households. It has also been observed that during the period of fiscal consolidation the propensity of savings increases and households tends to save more. The government of the U.K. had been following these two policy prescriptions during the period of recession. The government of the U.K. allowed the automatic policy stabilisers to operate freely in the immediate aftermath of the crisis. The government had cut the rate of Value Added Tax in order to boost the consumer spending. However, the expansionary fiscal policy of the government led to severe budget deficit. When the new government was elected in 2010 it had strongly volunteered to reduce the level of government spending as the budget deficit had become very high. The government introduced a number of austerity programs to reduce the budget deficit over the period of next four years (Carvalho, Eusepi and Grisse, 2012). The cuts in the overall spending have been broadly criticized by economists arguing that reducing the government spending drastically can harm the economy instead of helping it leading to a situation of double dip recession (Carvalho, Eusepi and Grisse, 2012). The government had also increased its focus on critical infrastructure projects so that it could increase the level of private investment in the country. Attracting investment is a primary concern for all the governments as it is a key to improve the overall level of economic activities in a country. The government of the U.K. has been consistently trying to improve the level of foreign investment in the country mainly by targeting the corporate taxes. The government has reduced the level of corporate taxes to 21% which is the lowest among the other OECD countries (Watts, 2011). Policies to mitigate unemployment It is the primary responsibility of the government of any nation to create favourable conditions of employment levels in the economy. Solving the problem of unemployment is one of the most important topics of discussion in macroeconomic theories. Any person is described as unemployed if he or she has been out of work for a long time. In an extended definition of unemployment people who are seeking employment has also been considered as unemployed. The problem of unemployment became extremely severe in the U.K. just after the period of recession. The unemployment rate of the U.K. had risen from 5.4% in 2008 to 7.8% in 2009 (Crown Copyright, 2015). The government had been consistently trying to solve the problem of unemployment but it had been unsuccessful as the level of unemployment had risen to 8% in 2012. Figure 2: Unemployment Rate of the UK (Source: Trading Economics, 2015) One of the main features of unemployment during recession was the growth in the level of youth unemployment. The government’s initial response to tackle the unemployment problem was ‘The Youth Contract’. This is one of the classic methods in macroeconomic theory that is used for combating unemployment (Monaghan and Inman, 2014). In this approach, subsidies are provided to the employers so that they get an incentive to hire the young people. The efforts also included providing apprenticeship support and placement support to enhance the chances of employment of youth. The government had also focused on apprenticeship programs during recession especially to the small companies. This can also be considered as an attempt by the government to improve the quality of the workforce as the young apprentice would soon enter the formal labour market. Despite the attempts made by the government to reduce unemployment, the results were far less than impressive. Jobcentre Plus Flexibility was a programme introduced by the U.K. government to combat unemployment. This was one of the measures advocated by the government to help people rejoin their old jobs (Monaghan and Inman, 2014). The government had partnered with the local authorities and private employers to provide them incentive to hire old employees. Work Programs were also introduced by the government to provide personalized support to the people who were in a more vulnerable position. The government had promised to pay the service providers depending on the amount of support they were able to provide to the most vulnerable section of the population. In 2010 the government had also introduced a special program for the disabled population so that the unemployment level in this segment can be reduced. Critics had a mixed review regarding the effectiveness of these employment programs. However, there is no denying the fact that the level of unemployment had shown signs of improvement in recent times and in the second quarter of 2014 it had touched the 6% mark (Monaghan and Inman, 2014). In absolute terms the level of unemployment had just reached below the 2 million mark (Crown Copyright, 2015). These figures suggest that the level of unemployment in the country is diminishing rapidly. Conclusion The government of the U.K. had become particularly very proactive after the recession. The idea of minimalist role of the state was discarded during the severe recession and the government had actively taken measures to bring the economy out of the recession. The government of the U.K. had first of all focused on raising the economic growth. Government had undertaken expansionary monetary and fiscal policies to boost the aggregate demand of the economy. The rate of interest was lowered and huge asset purchases were made by the central bank to pump money in the economy. The government had tried to handle both unemployment and inflation with the help of this monetary policy. It can be said that the government had been able to achieve impressive results in terms of keeping the inflation rates low. The unemployment policies undertaken by the government had only been partially successful in bringing the overall unemployment level. The fiscal policies undertaken by the government were mostly expansionary till 2010. The new government had however been keen on implementing austerity programs to reduce the extent of government debt. The government is trying to balance the cut of welfare programs with reduction of corporate taxes to attract fresh investment. Reference List Bank of England, 2014. Monetary policy. [pdf] Bank of England. Available at: [Accessed 8 January 2014]. Blanchard, O.J., Romer, D., Spence, M. and Stiglitz, J.E., 2012. In the wake of the crisis: leading economists reassess Economic Policy. Massuchussets: MIT Press. Carbaugh, R.J., 2013. Contemporary economics: An applications approach. New York: ME Sharpe. Carvalho, C., Eusepi, S. and Grisse, C., 2012. Policy initiatives in the global recession: what did forecasters expect? [pdf] Current Issues in Economics and Finance. Available at: [Accessed 8 January 2014]. CIA, 2014. The World Fact Book. [online] Available at: [Accessed 8 January 2014]. Crown Copyright, 2015. Helping people to find and stay in work. [online] Available at: [Accessed 8 January 2014]. Joyce, M., Tong, M. and Woods, R., 2011. The United Kingdom’s quantitative easing policy: design, operation and impact. [pdf] Bank of England. Available at: < http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb110301.pdf> [Accessed 8 January 2014]. Mankiw, G.N., 2014. Principles of macroeconomics. Connecticut: Cengage Learning. Mishkin, F.S., 2007. Monetary policy strategy. Massuchussets: MIT press. Monaghan, A. and Inman, P., 2014. UK unemployment falls below 2 million for first time since financial crisis. [online] Available at: [Accessed 8 January 2014]. The World Bank, 2015. UK GDP growth. [online] Available at: [Accessed 8 January 2014]. Trading Economics, 2015. United Kingdom unemployment rate. [online] Available at: [Accessed 8 January 2014]. Watts, M.J., 2011. The Imperative for Fiscal Austerity in the UK? Challenging Orthodox Economics. [pdf] Centre of Full Employment and Equity. Available at: < http://www.social-policy.org.uk/lincoln2011/Watts%20M%20P4.pdf> [Accessed 8 January 2014]. Read More