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Is current Macroeconomic policy consistent with the objectives of achieving a long-period of non-inflationary GDP growth?

Macroeconomics concerns itself with the management of the whole economy not just different parts of it.

Policy options:



      Direct controls

Fiscal policy was popular in 60-s, Keynes founded. After conservatives came, it was used as a support for monetary.

It is about government spending and taxation. Difference between them is PSBR. If spending is bigger than income from taxes - reflationary budget. The deficit is borrowed. Might have inflationary effect if country is working at near-full capacity. Only justified in economic slumps and then is used to supplement the aggregate demand, because a country can be in equilibrium with unemployment.

If spending is less than taxation income, deflationary budget. This cools the economy down and used in booms to fight inflation. Then PSDR (debt repayment) occurs (e.g. late 1980-s due to oil).

Latest budget was different from previous ones as income tax was cut (previously was risen). This will motivate people to work and encourage growth.

Surprisingly PSBR was also lowered and government is predicting even further reductions. This lowers the inflation in economy and prevents the overcrowding of the private investment, but latest figures show how the PSBR is bigger than forecasts, if its true inflation might occur.

Spending was increased in education and health. This is an investment into the human capital and is definitely going to benefit the growth.

This budget sounded too good, things that attract most publicity, were changed in favour, but they had to be financed by budget cuts elsewhere.

It is predicted that the economy has a spare capacity of 2.5%, so there should be no fear for inflation. Although the current growth rate is falling and the institutions are decreasing their predictions on the growth, taking the 1984 as an example, this should be just a minor feedback due to rapid recovery, and growth will return to normal rate in the following years.

Monetary policy was favoured after 1979. M. Thatcher liked it. There are two main directions:

      supply of money

      price of money

It is difficult to determine the exact supply of money. Nowadays Mo (cash and banks' deposits in the Bank of England) and M4 (Mo plus all bank accounts and shares, so called near money).

The idea is based on the equation MV=PT, if M rises other things remaining constant P should rise as well, so inflation occurs.

The M4 has been rising at an accelerated rat, but is not the main aim of the policy. Government can determine the money supply by issuing notes or selling gilts to non-bank institutions to reduce liquidity and credit creation.

Interest rates are most popular policy options. If the Bank raises the rate which it takes for lending to the LDMA as a last resort, then all commercial banks have agreed to follow it. If the rate is high less investment occurs, and the hot money flows into the country. If rates are low, it encourages investment and borrowing. Interest rates have lately been used to determine most of the economy, even the parts it had not invented to.

Interest rates were too effectively used at the beginning of 1990-s to cool down the economy. The sharp rise in rates led the economy to recession. Consumer spending was dramatically reduced, but the inflation was soon under control. In 1992 when interest rates were lowered output started to rise again. Surprisingly unemployment fell as well. All recoveries in UK have been consumer spending led.

Interest rates have been lowered again. Good for the growth and investment, but dangerous if lowered too much. So the full effects should be awaited before any further policy decisions are made. This has not been the case as rates are even further lowered, as GDP has slipped a bit. The excuse is the spare capacity in economy. This would definitely expand the economy and as the borrowing policy is made more strict and people still remember the over borrowing of late 1980-s and are indebted, the inflation and massive boom should not occur.

Special directives are for example prices and incomes' policy. They have not been used for a long time, because they cause wage drift, are more effective in public sector and after they are abolished the  wage will rise very quickly.

Controls on money supply can also be used. The Bank can order banks to have non-interest bearing accounts in it. They have not been used for a while because they damage the relationship between the Bank and other banks.

The business cycle existed long before governments, and it is general view, that demand management cannot eliminate it. But it can milden the cycle, the problem is only in the time-lag by which its policy operates. Still the government has managed to move most of the important economic measures in favour of reducing inflation and encouraging growth. This has been seen in the reduction of unemployment which itself benefits economy even further. If the government will not go too far with interest rate cuts, so that economy goes to boom, then the mid-term future seems good, although there are some suspicions that this might be the case.

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