Economic Policy and the Global Environment

This essay discusses the role of economic policies in obtaining macroeconomic stability and sustainable economic growth. It also describes the demand and supply-side policies adopted by some developed countries like the U.K.

Running head: ECONOMIC POLICY AND THE GLOBAL ENVIRONMENT
Economic policy and the global environment
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Author Note

1ECONOMIC POLICY AND THE GLOBAL ENVIRONMENT
The government of a country plays significant role to obtain economic growth in
long-term through obtaining macroeconomic stability in short-run. Economic stability helps
to obtain other macroeconomic objectives like stable price level along with sustainable and
stable economic growth. Consequently, economic growth helps a nation to increase
employment opportunity through increasing job creation and a balance of payments (Idris,
Bakar and Ahmad 2018). This happens because economic stability generates confidence and
certainty and this in turn influences the country to invest in human capital and technology. To
maintain economic stability in short-run, the government can adopt various governmental
policies in the form of fiscal and monetary policies along with floating exchange rate and
flexible labour markets (Corsetti, Kuester and Müller 2017). On the other side, there are
several policies that help to promote sustainable growth, which are, development capital,
technology policy, tax reform, decreasing deregulation along with increasing contestability
and competitiveness of the country. Hence, this essay has intended to describe those policies,
based on some instances of real scenario of some developed countries like the U.K.
The government of a country can maintain its short-run stability through applying
alternative monetary conditions, for instance, increasing or decreasing interest rates or
through contracting or expanding supply of money. Most of the governments and monetary
unions review this policy in each month (Keister 2017). On the other side, fiscal policy
includes tax cutting along with increasing governmental expenditures. Those demand-side
policies can be described in the context of U.K with the help of some macroeconomic
concepts.
The demand side policies try to increase aggregate demand (AD) of a country. This
helps a country to improve its economic condition during recession period or stagnant
economic growth. In this context, it can be said that those demand side policies can be
effective to increase economic growth when the country possesses spare capacity or negative

2ECONOMIC POLICY AND THE GLOBAL ENVIRONMENT
Price
Y1 Y2
Real GDP (Y)
LRAS
AD1
AD2
P2
P1
O
output gap (Blanchard and Summers 2017). However, during trend rate of growth, the
economy can experience inflation if AD increases further.
Figure 1: Increase in aggregate demand
Source: (created by author)
The most common tool that can influence economic activity of a country is monetary
policy. To increase aggregate demand, the government can decrease rates of interest, Lower
interest rates helps to reduce the borrowing cost and this in turn can encourage investors to
invest more and to increase spending of consumers (Praptiningsih 2018). In addition to this,
lower rates of interest forces people to save less through making spending comparatively
more attractive. Thus, lower rates of interest increase consumers’ disposable income and
decrease mortgage interest payments.

3ECONOMIC POLICY AND THE GLOBAL ENVIRONMENT
Figure 2: Trends of base rates and GDP growth rate of the U.K
Source: (Lee and Werner 2018)
According to figure 2, base rates of the U.K have decreased in 2009 by 0.5% as the
government has intended to stimulate economic growth rate within economy (Lee and
Werner 2018).
However, in this context, it can be said that lower rates of interest may not always
increase spending. If the company falls within a liquidity trap than lower rate of interest
remains unable to increase spending as at this time people try to pay back their debts. This
phenomenon has also occurred in U.K during this period. The government has reduced
interest rates though spending of the country has not increased by large extend (Frank 2018).
Banks have not wanted to lend money due to shortage of liquidity. As a result, the entire
situation does not follow theoretical concept regarding cheap borrowing for lower rates of
interest and has become difficult to create credit during in reality. Thus, this governmental
policy has become unsuccessful to bring economic growth in U.K.

4ECONOMIC POLICY AND THE GLOBAL ENVIRONMENT
The monetary policy has some other criticisms. For instance, lower rate of interest
cannot distort economic growth of this country for future. After 9/11, the U.S.A has
experienced economic uncertainty and consequently has reduced its interest rates (Jens 2017).
These lower rates of interests have led people to take huge amount of loans and mortgages
and consequently the housing bubble has occurred. Hence, from this economic outcome it
can be said that, reducing interest rates at wrong time can influence a future asset and housing
bubble that further can destabilise economic growth. However, during financial crisis in 2009
and 2012, the country has not experienced any danger regarding housing bubble and keeping
interest rate at zero level has become an appropriate decision of the government.
The government can also obtain long-term economic growth through applying
appropriate fiscal policy, such as, increasing government expenditure and decreasing tax.
This lower income tax can increase disposable income of citizens and consequently aggregate
consumer expenditure may increase further (Jordà and Taylor 2016). Furthermore, higher
spending of the government can create jobs and this in turn can give and economic stimulus.
However, expansionary fiscal policy has some problems as it increases government
borrowing. Hence, to overcome this excess expenditure, the government borrows money
from private sector. If the economy is growing one, than it can crowd out the private sector
through its higher government borrowing. In addition to this, some economists have criticised
this expansionary policy through stating that it can increase the size of governmental sector
permanently.
On the other side, a rapid fall private spending can increase the saving ratio and
consequently, expansionary fiscal policy can increase the economic development without
doing any crowding out.

5ECONOMIC POLICY AND THE GLOBAL ENVIRONMENT
Figure 3: Net borrowing percentage of GDP of the U.K
Source: (Bozio, Emmerson, Peichl and Tetlow 2015)
The above figure has represented net borrowing percentage of GDP in U.K. It can be
observed from above figure that borrowing of this U.K government has increased in 2009 and
2010 as they have followed expansionary fiscal policy (Bozio, Emmerson, Peichl and Tetlow
2015).
Floating exchange rates also stabilise economy. During negative supply or demand
side shock, the economy can be affected adversely and this in turn can decrease he exchange
rate further. As a result, export price can decrease and the country can increase its exports and
consequently the country can experience competition in international market. Hence, this
devaluation helps the country to increase its domestic and international demand, which
further can help the specified economy to obtain long-term economic growth (Corsetti,
Kuester and Müller 2017). For instance, both Iceland and Argentina have experience rapid
devaluations and this further them to recover their economic condition (Benediktsdóttir,

6ECONOMIC POLICY AND THE GLOBAL ENVIRONMENT
Eggertsson and Þórarinsson 2017). In addition to this, the U.K also has benefited in 1990
from leaving the mechanism of exchange rate. However, this devaluation has disadvantage as
well; for instance, it can increase inflation within economy and consequently standard of
living may decrease as well.
Hence, without any unsustainable bust or boom, those demand side policies cannot
increase the economic growth rate. For instance, in the U.K, taxes have been decreased to
increase a backdrop of increasing housing prices and inflation. This in turn has helped the
economy to achieve rapid economic growth. However, this growth has become unsustainable
due to inflation.
The government can also apply supply side polices to improve economic growth
through improving efficiency and productivity of the economy. Those policies can be
described as follows:
Lower income tax can influence a person to work more and this in turn increase
labour supply. Hence, this further helps aggregate supply to increase further. In addition to
this, decrease in income tax helps disposable income of the person to increase further and this
in turn improves aggregate demand of the county. Consequently, the country can experience
economic growth. Better union relationships between employees and employers along with
flexible labour market and privation can also influence an economy to produce more output
and this further can improve economic growth of the country through producing more outputs
(Zhang, Nie, Shi and Zhang 2018). In this context, technological policy can be taken under
consideration as technological development helps firms to produce more and for this, the
government can provide incentives to those private entities in the form of cheap loans, grants
of tax relief. In addition to this, the government can provide incentives to a person to start a
new business or for small businesses to expand further. The other important factor to grow
both developing and developed countries is foreign direct investment (FDI). Higher amount

7ECONOMIC POLICY AND THE GLOBAL ENVIRONMENT
of FDI helps the country to improve its economic condition and to obtain this the government
needs to reduce unnecessary regulations.
To obtain long-term economic growth, short-term macroeconomic stability is
essential. Sustainable economic growth arrives due to increase in aggregate supply and
demand. However, this growth depends on supply-side developments as inflationary
problems and balance of payments can influence by less amount when the factors’
productivity improves.

8ECONOMIC POLICY AND THE GLOBAL ENVIRONMENT
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9ECONOMIC POLICY AND THE GLOBAL ENVIRONMENT
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