The two major key government policy objectives for the economy of the UK can be identified as the level of unemployment and the level of inflation, as these are the two factors that are responsible for reducing the welfare of the economy. The economy of the UK is more inclined to use the monetary policy for controlling inflation. On the other hand, the economy of the UK is more prone to use the monetary policy for controlling the negative impact of unemployment on the economy. The content of this essay is going to describe how inflation and unemployment are working for reducing the welfare of the economy and what is the macroeconomic policy that is most commonly used by the economy UK during the duration of 2010 2022 of the economy (Eggoh, 2014.).
Inflation should be defined as a situation of rising prices, and therefore, the most common effects of inflation on the economy of the UK can be identified as a decline in purchasing power of the citizens of the economy”, reduces the value of savings and pensions, encourage excessive spending, bring more inflation in the economy, enhances the cost of industrial borrowing and thus push the economy more towards in an uncontrolled situation.
The direct impact of the rise in prices of the total goods or services of an economy was the decline in the purchasing power of the citizens of the country, who have been forced to reduce their demand for goods and services as well as consumption as the prices of goods and services has increased without any proportional increase in the income or earning level of the people of the country. If due to the inflation, the people of the country are losing their purchasing power, then it is obvious that the consumers of the country have little scope to enjoy any kind of consumers surplus as the rising prices of goods are not giving the scope to the consumers to pay the price for a unit of good for which the consumers were really ready to pay a higher amount. Thus inflation is responsible for directly reducing the consumers surplus as well as the welfare of the economy (Thanh, 2015.).
Adding momentum to inflation and is causing a situation of hyperinflation:
Again as inflation also pushes up the prices of goods and services on a continuous basis and thus provokes a section of the wealthy buyers to buy in advance in the apprehension of a rise in prices in the near future. Thus a situation is created that drives more inflation in the economy, and the growth rate of inflation gets momentum in the economy. Thus the phenomenon of enhanced momentum in inflation acts as the main driving force behind the concept of “demand pull inflation, where too much money is chasing too few goods as the purchasing power of the consumers has declined (Svensson, 2018.).
Inflation that provokes a part of the consumers to buy and consume more in the apprehension of the rise in prices in the near future automatically enhances more inflation in an economy, and the overall growth rate of inflation receives a new quicker pace of growth which enhances the cost of borrowing and leads the investors to reduce their demand for investment. Thus a component of reduction in aggregate demand also arises from the side of the investors. This situation acts as a driving force behind the cost push inflation that enhances the prices of goods and services due to the rise in the prices of input as well as wages in the economy (Charles, 2016).
The fig 1 shows the duration of the movement of inflation for the period of 1989 to 2022. However, the focus of the analysis will only be over the period of 2010 2022 and thus is indicating the fact that the first half of the period (2010 2013) was the period when the economy of the country has experienced a high level of inflation as this was the period when the policymakers of UK are using a policy of monetary easing as it was essential for protecting the economy from the deep impact of the 2008 depression.
A look at the GDP growth rate of the economy of the UK, it can be seen that the country experienced a sudden negative GDP growth rate during the period of 2008 2009, and then the economy took till 2011 to recover and attain a positive GDP growth rate. Thus in the post recession period of 2008, the economy of the UK received extensive monetary support as well as fiscal support as an initiative to stimulate the economic growth of the country, and that is why it can be seen that till 2016 the economy of the UK has experienced a continuously rising as well as dropping rate of inflation.
However as it was not possible for the economy of the UK to impose a stringent monetary policy, that is why the economy of UK has just started to use a monetary policy with the objective of attaining a moderate level of inflation as well as price stability the economy has seen a surge of the inflation rate from time to time.
The monetary policy for controlling inflation is being regulated by the Monetary Policy Committee (MPC) on behalf of the Central Bank of the UK. The policy development being started with the decision regarding the target level of inflation is to be achieved. On average, the Government of the UK tries to stabilize the economy at a 2% level of inflation (Bank Of England, 2022).
The MPC first focuses on the different economic indicators to forecast the possible future rate of inflation and the study of those economic indicators like the GDP growth rate of the country, the GDP per capita, “the level of unemployment” helps the economy to realize that to what extent the economy is being heated and what can be the possible level of inflation of the economy in future.
Now, if the MPC assess that the level of inflation is going to increase in the near future, then the MPC will enhance the rate of interest for enhancing the cost of borrowing. If the cost of borrowing increases, then the consumers will feel less inclined towards borrowing and spending. For example, if the consumers find that the rate of interest rate has increased, then they will be discouraged to take a car loan to buy a car or a home loan to buy a home. Thus the rise in interest rate will reduce the supply of money in the economy from the side of the consumers.
On the other hand, a rise in interest rate also encourages the consumers to save more rather than spend and again, the enhancement of the savings activity reduces the supply of money in the economy.
Now looking to the side of the investors, it can be observed that the investors also feel discouraged to borrow when they find that the rate of interest or cost of borrowing got increased in the economy.
Additionally, the rise in interest rate also leads to the decline in the amount of disposable income in the hand of the mortgage holders.
The rise in interest rate also leads to the appreciation of the exchange rate of the home country and thus reduces the volume of export and increasing the number of imports for the economy.
Thus the rise in the interest rate leads to a decline in the inflow of money from both the side of the consumers as well as that of the investors, and this reduction in the supply of money is going to pull down the inflationary pressure in the economy. The decline in disposable income in the hands of the individual and the decline in export for the home country that is applying the monetary policy also contributes to the process of reduction in money supply for the economy that automatically pulls down the inflationary pressure for the economy. (Bank Of England, 2022)
However, to what extent the interest rate to be increased to reduce the supply of money in the economy appears to be the complete discretion of the MPC and the MPC decides the rate of interest of the economy depending on the level of the current level of inflation and the target level of inflation to be achieved by the economy.
As defined by Fig 3, the decline in the aggregate demand of the economy is leading to an inward shift in the aggregate demand curve of the economy from AD1 to AD2, which causes a small decline in the equilibrium level of output of the economy from Y1 to Y2 and large proportional decline in the price level of the economy from P1 to P2.
The other factors influencing the chances of success:
When the policymakers of the UK are just using the monetary policy for controlling the inflation of the economy, then it is essentially required for ensuring the success of the policy taken that the fiscal factors of the economy remain unchanged. In other words, if the economy is looking to stabilise the price level of the economy by reducing the level of interest rate the economy, it is being assumed that the fiscal tools like the tax rate or the government expenditure will either be reduced or should remain unchanged. If the economy is looking to for enhancing government expenditure or reduce the tax rate along with the rise in the rate of interest so the efficacy of the monetary policy will automatically get reduced as a tool for controlling the high level of inflation in an economy. Additionally, the factors like political and financial stability in both the local region as well to that of the global region is essentially required to consider for ensuring the effectiveness of the monetary policy in dealing with the inflationary pressure..
If the level of unemployment got increases in the economy, then it is obvious that the people of the economy have little scope to earn and is left with little disposable income, and a difference is being created between the employed and earners and unemployed and non earners leading to further inequitable distribution of the resources of the economy which is a definite indication of the reduction of the economic welfare of the country.
The presence of a high level of unemployment rate in an economy acts as a source of wastage of resources as due to the shortage of the active workforce, it will not be possible for an economy to utilize its resources to the fullest extent.
The presence of a high level of unemployment in an economy also leads to the generation of redistributive pressure that brings distortion in the process of distribution of goods and services among the agents of the economy and thus leads to a decline in the welfare of the economy.
The inequitable distribution of resources in an economy as caused by the presence of a high level of inflation rate leads o the generation of social conflict and a social disturbance between the haves and have nots of the society sets in.
Due to the above discussed negative impact as realized by an economy due to the presence of a high level of inflation, the policymakers of UK are trying to control the level of unemployment in the economy.
A look to the movement of the unemployment rate of the country till 2008 was low enough. However, as the economy of the UK is an open economy, the depression of 2008 has adversely affected the economy of the UK and the economy has started to see a surge in the unemployment rate from 2009 onwards and the unemployment rate of the economy has increased to the highest level of 8.04% during 2011.
The application of the monetary policy has started to show its effect in lowering down and then stabilising the unemployment rate of the country.
The application of the monetary policy for controlling the rate of unemployment in an economy
The government of UK or better to say the MPC on behalf of the central bank of UK takes the policy to reduce the rate of interest of the economy.
A decline in the rate of interest of the economy just stimulates the borrowing by the consumers for the purpose of enhanced consumption and investment. In other words the lowering of the interest rate just stimulates large consumption being backed by loan.
The decline in interest rate also enhances the demand of loan from the side of the investors who enhances their demand for borrowing as the cost of borrowing got declined with the declined rate of interest in the economy.
The decline in interest rate also causes depreciation in the home exchange rate in relation to the foreign currency and thus enhances the volume of export (Bank Of England, 2022).
Thus the overall impact of the monetary policy application through the reduction in interest rate results in the rise in aggregate demand of the economy.
When the Aggregate demand for the economy increases then the aggregate demand curve shifts from AD1 to AD2 causing a larger rise in aggregate goods and services in an economy in comparison to a slight increase in price from P1 to P2 . The rise in aggregate demand due to the application of the monetary policy by reducing the rate of interest of the economy generates rise in employment or decline in unemployment by the same amount of Y1 Y2.
The other factors that are crucial for ensuring the effectiveness of the chosen monetary policy for controlling unemployment level of the economy can be identified as the government expenditure or the taxation rate that should be either kept constant or will be reduced for supporting the efficacy of the monetary policy of the economy.
From the above discussion it is clear that the decline in unemployment or the rise in employment level of an economy should be accompanied with some degree of inflation. The process of controlling the unemployment in the economy or better to say the process of raising the rate of employment in the economy is dependent over rise in the equilibrium output of the economy and therefore the acceptance of certain level of inflation has become a necessary for raising the level of employment of the economy.
Thus it is the expertise of the members of the MPC to set the rate of interest of the economy as the degree of the rise in interest rate or decline in interest rate will decide that how the price level of the economy will either rise and decline and how the output or employment creation will either rise or decline in the economy (Issa, 2018.)
Thus the policy makers from UK are capable of using both the fiscal as well as economic policies for controlling the aspects of inflation and rising unemployment. However in the present scenario the policy maker from UK has just managed to control the inflation as well as unemployment by using the monetary policy tools only. The analysis is assuming the fact that the fiscal policy tools like tax rate , the political situation , government expenditure ,either will remain unchanged or will work in that direction so that it can support the goal of the monetary policy in controlling the level and inflation and unemployment of the economy.
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