UK's Macro Economic Situation in the Last Five Years - Coursework Example

UK’S MACRO ECONOMIC SITUATION IN THE LAST FIVE YEARS Introduction Macro economics is the study of the entire economy as a whole in terms of; the total amount of goods and services produced, total income earned, level of employment and the general behavior of the prices. It aims at addressing the factors that result into the economy to grow over time, what causes short-run fluctuations in the economy and the values that affect the economic indicators. These economic indicators include economic growth, price stability and full employment. The focus in Macro economics is on the movement of the economy as a whole. The focus is generally on unemployment, inflation , government policy and the variables that are studied in micro and macro economics and there influence. Economics is the science of wealth creation and it involves formulation of theories that are debated and tested leading to some being accepted, rejected or modified. They all involve the question of what to produce using the scarce resources, how to ensure stable prices with full employment and how to ensure and provide a raising living standard for the people today and tomorrow.( Sloman 2010) John Keynes Ideas John Keynes was (1883-1946) was a British economist whose ideas greatly impacted on the modern day macro economics with an effect on the British social liberalals. In 1936 he broke from the classical theory of economics with the publication of the General Theory of Employment, Interest and Money that advocated for an interventionist policies by the government. The main tool by which the government will intervene included the fiscal and monetary policy to mitigate against the adverse effects of capitalism that is recession, depression and business cycles. His theories are what are known as the Keynesian theory of economics. For the classical view held that in a recession that wages and salaries would decline to restore full employment, but Keynes held that the opposite was true. Falling prices and wages depresses peoples incomes thus preventing a revival of spending. Keynes insisted that a direct government spending was necessary to increase the spending. In his theory one persons spending goes towards another earnings thus when he/she is spending her money she/he is infect supporting another’s earning and the circle continues and this is what helps and support the normal function of an economy. When a depression hits, people hoard money and this action deprives the economy of money in circulation making it to be at a stand still. These ‘crunch’ can be best corrected by the government intervention so as to increase spending; by increasing money supply or by buying things on the market itself. These is different, from the classical school of thought. The classical school of economic thought began with the publication of Adams Smith monumental work in 1776 that titled the Wealth of Nation. The book identified land, labor and capital as the three main factors of production that contribute to a nation’s wealth. To smith the ideal economy is that which is self regulating market that operates on the forces of the demand and supply thus automatically satisfying the market. He referred to this market mechanism as the invisible hand that, leads all individuals in the pursuit of their own self interest so as to produce the greatest benefit for the society as a whole. He embraced such notion as laissez-faire, into his own economic theories and rejected the notion that only agriculture was productive. This theory excluded the incorporation of the public sector in the market as the market will achieve balance on its own. The main difference between the classical and Keynesian theories of economics involve the role of the state in the economic life of the individuals of which when summed up has an impact on the overall macro economic condition of a nation. Keynesians economics warns against the practice of too much savings and spending in the economy. Keynesian advocates for wealth redistribution to the poorer section of the economy as the poor are most likely to spend the money hence spurring the economy. (David & Murphy 2009). Economic Growth, Inflation and Unemployment Economic growth is a concept that is used to denote the increase in the per capita of the gross domestic production or other measures of the aggregate income of anation. It is the positive change in the level of production of goods and services over a certain period of time. Nominal growth is growth with the inclusion of inflation while real growth is one that is without inflation. This is usually measured in terms of the change in the gross domestic product of a given country that can either be positive or negative and it pertains to the quantity of goods and services produced. A negative growth is where the economy has contracted mainly due to recession or depression that is an adverse form of recession. Economic growth is brought about by technological innovation and external factors that impact positively on the economy e.g. foreign direct investment. Inflation is the general rise in the level of prices of goods and prices in a given economy over a given period of time. The increase in the prices of the goods and the services leads to the erosion of the purchasing power of the money. The rate of inflation in a given economy is measured in terms of the inflation rate. To most government the objective is to keep the inflation rate to single digits and the trend has shifted from calculating the inflation rate using the arithmetic mean to using the geometric mean. Unemployment on the other hand refers to those persons who are willing and able to work but they are lacking jobs. Labor force refers to all these people who are able to work weather employed or unemployed and the unemployment rate is measured as a percentage of those who are unemployed in the labor force. In the administration of the financial system, the government draws the line between the short term growth and stabilization of the economy and the long-term growth economic growth. The short term economic growth and variation is known as business cycle.(OSullivan s cycle & Sheffrin 2005) Keynesianism and the business cycle One of the major theories that involve the business cycle is that proposed by John Keynes in his book the general theories of employment, and money (1936) that was against the classical ideas of the business cycle. In the book he challenged the generally accepted perspective that the way forward to ending a depression is by cutting expenses- mainly wages so as to result into full employment and a revival of the economy. In individual firms a reduction of wages may make it possible to expand production and increase employment. But wage cut across an industry or economy will result into a reduction in consumption and aggravate further the state of the depression or a recession. To Keynes satisfactory business conditions pertain and depend on maintaining full employment. His arguments attempts to explain why full employment cannot be achieved and how declining business activity is a consequence. The goal of a business man is profit and he looks at the propensity of the population to consume, the prospective return on capital investments and the rate of interest in making his decisions; as when income increases, expenditure increases but at a reduced rate living a surplus for savings. But, both income and expenditure do increase as a result of investments hence creating a contradiction as investments only raise when there is consumption that results out of spending, otherwise there will be no demand for the increased production or consumption of all that has been produced if savings has not been accomplished. Business people are generally inclined to invest in new products enterprise if the returns are larger than the current interest rate. Increase in the rate of interest results into inflation and erodes the ability to save and it is not dependent on the fluctuation of the demand of money but its just a perennial tradition(according to him). A high interest rate will postpone investment and encourage hoarding hence cutting down of wages will only redistribute income to property owners (of capital) who are few in a given economy (see figure 1). The United Kingdom Economy in the Last Five Years The United Kingdom economy is the third largest economy in Europe after Germany and France and the sixth largest in the world. The Gross Domestic per capita of the UK is one of the highest in the world and it belongs to the G7 and the G20. A former colonial power it’s a member to international bodies like the World Bank, World Trade Organization, the Commonwealth etc. In 2008 the British economy shrunk for the first time for the last sixteen years. The GDP of the country shrunk by 0.5% between July and September of the year showing clearly that the country was on the verge of a recession. (The biggest drop in 18 years). The annual economic growth rate of its economy grew from 1.1% in 2006 to 0.7% at the start of 2008. This dipped to -2.6% at the start of January that was as a result of the global recession brought about by the financial crisis whose origin started in the USA.(Alex Brummer.2008). The economy’s GDP then contracted to –0.35% at the end of 2009. In the first quarter of 2010 the GDP grew by 0.4 % and the second quarter it’s projected to grow at 0.25%. (See figure 2) The inflation rate in the UK Increased from a low of an average of 2.2% in the early 2005 and had been raising steadily to a rate of 5.2% at the end. The trend started to shift to a decline where it reached 3% at the start of 2009. By the third quarter of 2009 the rate reached 1.1% before increasing at an increasing rate to a maximum of 3.5% at the start of 2010. By March the rate reduced to 3.4% before climbing at the present rate of 3.4% (figure 3). The unemployment has been the course of much debate in the UK especially during this period of elections. The rate of the unemployment does not include those in the military, those who are not looking for work and those who are institutionalized. The inflation rate has reduced from an average low of 5% in 2005-2006 and has been raising steadily after the effect of the global recession and financial crunch started to be felt. The global financial meltdown resulted into massive job and business losses. By January 2009 the unemployment rate was fluctuating between 6.4% and 6.2%. The rates by July 2009 were 7.9% and at know stands at 8% by March 2010 (See figure 4). State Intervention Monetary policy is a method by which a nation tries to control and regulate the supply of money so as to achieve low inflation and this protects the value of the money, laying a foundation for the long term stability for economic growth. This is usually done by the central banks which in Britain is the Bank of England. It uses two types of tools i.e. the interest rate which it use to lend to other banks and financial institutions(bank rate). This bank rate affects money interest rates charged by the banks and other institutions. It also uses direct injection of money (quantitative easing) into the British economy through purchasing of the government or corporate bonds. Fiscal policies are concerned with how governments raise there revenues primarily out of taxation. An increase in the Bank Rate raises market interest rates while a decrease lowers them. Also higher interest rate lowers them as it reduces money supply through increasing of interest received on savings and raising the cost of savings (Gowl 1978) . This lowers consumer spending leading to a downward pressure on prices. Lower interest rate stimulate consumer spending especially when the inflation rate is below the governments target for the year. The global financial crisis necessitated the need to inject more money to the economy that was/is under a recession. This was achieved through lowering of the bank rate so as to increase the money supply; cutting down of the value added tax by 2.5% from the 17.5% to 15%- a fiscal policy measure to tame inflation and the usage of the quantitative easing to pump up additional money to the economy. Other measures involve bailing out of the UK’s three biggest banks, the rescue package to its car manufacturing industry and undertaking measure to bring the mortgage lending rates to pre 2007 levels (Carl-Johan Lindgren et al.1996). CONCLUSION. The events of recent years though the global economic crunch has shown that nations can no longer depend on the forces of the market to correct the downward trend of a rapidly declining economy. State intervention is therefore a prerequisite in correcting the market irregularity and stimulates the economies back to the growth path. This implies formulating policies that are in line with Keynesianism. This result into a capitalistic economy shifting to a managed economy especially in times of crisis. References John Sloman. (2010). Essentials of economics.ed 5. Prentice Hall/ Pearson David Gowl.(1978). Monetary policy and credit control: the UK experience. Taylor & Francis. David S.& J. Murphy.(2009). Unravelling the Credit Crunch CRC financial mathematics series. CRC Press Carl-Johan Lindgren et al. (1996) Bank soundness and macroeconomic policy. International Monetary Fund. Paul J. J. Welfens & John T. Addison(2009) Innovation, Employment and Growth Policy Issues in the EU and the US. Springer Alex Brummer.(2008). The crunch: the scandal of Northern Rock and the escalating credit crisis. Random House Business Books. Commonwealth Secretariat.(2008) Commonwealth finance ministers’ reference report. Henley Media Group in association with the Commonwealth Secretariat John Redwood.(2009). After the credit crunch: no more boom and bust. Middlesex University Press. Great Britain: Parliament: House of Commons: Treasury Committee(2009-10). Pre-budget Report 2009: Fourth Report of Session 2009-10; Report, Together with Formal Minutes, Oral and Written Evidence. The Stationery Office. Arthur OSullivan& Steven M. Sheffrin.(2005). Macroeconomics: principles and tools. Ed 4. Pearson Prentice Hall. FIGURE 1 A TYPICAL BUSSINESS CYCLE. Source http://southdakotapolitics.blogs.com/south_dakota_politics/images/2008/01/19/business_cycle_01.png&imgrefurl FIGURE 2 Figure 3 Figure 4 Read More