How successful has the government and the Bank of England Essay

The bank of England and the government has worked tirelessly to counter the threat of recession and inflation particularly over the last two years. Both have worked in tandem and introduced a number of economic policies to ensure that the country does not become the target of the dreaded recession. The problems came about due to the sub-prime mortgage problems which originated in the USA. Homes began to get repossessed as home-owners were unable to repay their mortgage arrears. This in turn was felt by the UK economy and the Bank of England was forced to tamper with interest rated to ensure that repossession levels were kept reasonably low. In addition to this we have seen additional economic problems i. e. the folding of Lehman brothers but the bank of England and the government has worked hard to soften the blow. (Jones, 2007,pg 13) The Bank of England has controlled the level of interest rates it sets via the manipulation of short term interest rates and has taken extra care since the credit crunch kicked in 2 years ago. They have controlled the Monetary Policy Committee (MPC). If the MPC thought that the demand was set to rise too fast, then they would have increased the interest rate, but if they thought demand was growing at a slow rate, or maybe even possibly falling, they would then have reduce the interest rate. This was known as the transmission mechanism. (Bernake, 2006, pg 27) The government since November 2006 has introduced many different internal consumer demand changes that affected the general public. Firstly there was consumer borrowing. Many consumers used this method to borrow money in the form of credit cards or loans before the credit crunch but the government revised in at the start of 2007. As the interest rates increased, it became less attractive to borrow at that time as repayments were be higher and still are high. (Jones, 2007,pg 24) Next, there was the issue consumer debt. Because of levels of borrowing at present, higher interest rates meant higher repayment costs. This was known as debt servicing. This left the consumers as a whole with less surplus income to spend as this led to a fall in demand. Mortgage debts were present because most people had to borrow to purchase a home before the credit crunch and the payments on their property varied based on the interest rate but were generally high since 2006. Higher interest rates meant higher repayments which ultimately led to a fall in demand. The Bank of England declined to substantially cut interest rates but a cut of 0. 5% was made in September 2008. Expectations were another point to consider. If interest rates increased then people may have less confidence in the future of the economy and may hold off purchases as they became concerned about a possible fall in income or even worse, the possibility of becoming unemployed. Asset prices may have been affected by interest rates, with an increase in the interest rate meant asset prices may fall. This may be shares or perhaps houses. If asset prices decreased then people felt like they have less money and thus cut back on spending. (Mankiw, 2006, pg12) Many businesses borrowed money from banks and it is this demand changes that affected the interest rates which ultimately affected how much the business owed the bank. One solution is that businesses could have agreed with the lender that funds were only drawn when needed meaning interest would only be paid on amounts drawn and the business would not have to pay interest on unused funds of the loan. The government and bank of England has worked systematically to keep the economy flowing over the last two years where the UK has been on the brink of recession. What this is saying is that they could have predicted how interest rates would fall on rise based on the current state of the economy and the position it had within the world trade. If the economy is doing well then we can say that interest rates will be affected in a way in which we can predict for the future. In this case they may rise but if the economy is doing poorly then they may fall in the future. (Mankiw, 2006, pg22) To conclude one would say that the Bank of England plays a major role in the stability of this country. Without it this country would have no financial stability to be a world player on the trade market like it is now. b) Describe and evaluate the main macro economic policies used by the British government and the Bank of England over the last two years? (november 2006 – november 2008) The government and the bank of England have used a number of macro economic policies over the last two years. They are – Monetary Policy Government has used the monetary policy to ensure a slow steady growth in the money supply which moves in line with the growth of real output, around 1% or 2% per year since 2006. The Bank of England controls rates of interest rates, and by holding interest at a steady level, inflation would also be kept level. ( Bernake, 2007, pg 10) Fiscal Policy The fiscal policy is the policy used by the government to help direct the economy by deciding how much they should spend, which resources to spend money on, how much taxes should be risen or decreased or waived. An example of fiscal policy in use is when the government from 2006 used fiscal policy to change the level of economic activity due ton the credit squeeze. After 1979, the Conservatives believed that using monetary policy to control the money supply was more important but the government from 2006 only highlighted this area of macro economics due to the credit problems. Businesses used the fiscal policy as their main policy as they believe that interest rates played an important part in influencing aggregate demand. They used monetary policy as a back up to fiscal policy. When businesses were faced with a recession in the economy, they did not not welcome the change in the fiscal policy to decrease public spending and increase taxes. When there is a boom in the economy fiscal policy is used by Keynesians to decrease public expenditure and increase tax but since 2006 the opposite occurred. Monetarists used fiscal policy to reach a near balanced budget which they felt would prevent large increases in the money supply and inflation. As monetarists did not believe in the short term counter cyclical policies, they felt that it was important to stabilize the money supply in the medium term to counter the threat of inflation. ( Bernake, 2007, pg22) Incomes Policy The government looked at the incomes policy and aimed to reduce inflation rates by ensuring that the growth rate of incomes is the same as the growth rate of productivity. If the government could slow down the rate of increasing incomes, the incomes policy could restrict the rate at which costs were rising. A voluntary incomes policy was when the government tried to persuade trade unions and firms to accept that wages should not be allowed to increase more than the expected rise in Gross National Product. A statutory incomes policy was when the government passes legislation to limit or freeze increase levels which took place in June 2007. Price Controls Policy The government applied price controls to control inflation rates in Feb 2007.? Price controls sometimes hold prices below the equilibrium level, causing shortages.? If costs rose whilst prices were held down, firms may be unable to make profit.? When cost-push inflation is the main inflation, prices need to be controlled to reduce the problem. The Bank of England was wary of this and welcomed the change. EFFECTIVENESS OF THE POLICIES Monetary Policy Keynesians use monetary policy during a recession and in reverse during a boom. Monetary policy is used to lower interest rates, ease controls on bank lending and hire purchase during a recession. The effect this has on the government objectives was that unemployment would fall due to increased expenditure causing greater demand for goods and services and more need for employees to produce more goods. The threat of Inflation increased due to the less favourable balance of payments due to increased spending on imports. (Bernake, 2006, pg 26) Supply Side Policies Supply side policies also reduced inflation by de-regulating the labour markets and encouraging higher levels of productivity. Supply side economists felt that unemployment levels would drop when there was lower tax and reduced benefit levels but since Nov 2006 the government nor bank of England did not reduce tax. When unemployment had been reduced, the threat of inflation remained low, and if trade unions had less power, it would prevent workers demanding higher wages, which also helped to keep inflation low. By allowing market forces to operate, the bank of England felt that the economic growth would increase, as goods would be supplied where they were needed.? As supply side economists felt that supply factors were important and that they would concentrate on ensuring there was enough supply for consumers, preventing more imports having to be purchased, helping to keep the balance of payments level steady and keeping the economy running in a very shaky period. (Bernake, 2006, pg 29) Price Controls Policy If the government inflation fell by imposing price controls, it can often cause firms to go out of business if costs rise and prices don’t. Firms may be unable to keep employees if costs are rising and they are not making enough profit, causing increased unemployment. Economic growth would deteriorate, as firms may find it difficult to expand. Consumers may purchase goods from other countries if prices are unreasonable causing the balance of payments to decrease, making the UK less competitive. Bibliography Books Jones. C. Introduction to economic growth. Second edition. W. W Norton and company Ltd (2007) Mankiw, G.Macroeconomics. 6th ed. 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