Since the global financial crisis of 2008, the UK government has been implementing various policies to combat the recession and stimulate economic growth. This essay will look at how effective the fiscal and monetary policies used since the crisis are in achieving the four-macro economic objectives. In addition, I will provide my input on the best way the UK government can carry out these policies.
Monetary policy affects the aggregate demand by altering the supply or cost of money. One of which is the alteration of the rate of interest. By reducing the interest rate, it encourages consumers and businesses to borrow and spend or invest instead of saving their money. As a result, the supply of money increases. When there is more money, it causes a shift in the demand curve for goods and services, which will lead to inflation and a higher output. Please refer to Appendix A. Higher output requires factors of production, which will lead to lower unemployment rates.
Since the global financial crisis in 2008, the interest rate was reduced from 5.25% to 0.5% in over the span of a year. The interest rate was set at 0.5% on 05 March 2009 and since then; the interest rate has remained unchanged. Please refer to Appendix B. The reduction of the rates was to provide a stimulus to encourage consumers to borrow and spend in order to keep the economy growing. As shown in the household-spending graph, household spending decreased during the recession period and only started picking up during the 2nd quarter of 2009. This shows that the low interest rate has been successful in stimulating demand, leading to economic growth. Please refer to Appendix C and D. There is also a direct relationship between spending and inflation. During the 3rd quarter of 2008 when household spending decreased, inflation growth started to fall. Whereas, during the 2nd quarter of 2009 when house spending increased, inflation growth started to rise. Please refer to Appendix E. However, the inflation rate was fluctuating which shows that low interest rates are not the only factor affecting the aggregate demand. However, even though UK spots a positive GDP annual growth rate since 2010, unemployment remained high. Please refer to Appendix F.
In my opinion, how effective low interests rates are to encourage consumers to borrow and spend depends on the elasticity of the demand for loans. If the demand for loans is inelastic, a sharp reduction in interest rates will only increase the loans by a small amount. Please refer to Appendix G. In this case, lowering the interest rates to 0.5% is not enough to stimulate demand. As a result, quantitative easing, another monetary policy is being utilized, as bank rates could not go any lower. Although there are other underlying factors that contribute to the high unemployment rate in the UK, it is shown that reducing bank rates is not the key to solving this problem.
Low interest rates will also alter the behaviour of consumers, businesses and banks....