ECON6001 Economic Principles: Analyzing Fiscal Policy During Crisis

This case study provides a comparative analysis of economic policies in Sweden and the United Kingdom, focusing on monetary policy effectiveness in controlling inflation and fiscal policy utilization during the 2008-09 financial crisis. It evaluates Sweden's inflation targeting approach, highlighting its benefits in reducing inflation volatility and fostering employment, and compares it to the Bank of England's strategies, including the role of the Monetary Policy Committee (MPC). The study also assesses the fiscal policy responses of both countries, examining Sweden's budget surplus target and the UK's nationalization efforts and interest rate adjustments. Ultimately, the analysis evaluates which country was more successful in minimizing the negative effects of the recession, considering factors such as net lending, government debt, and GDP growth.

ECON6001 Economic
Principles
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Table of Contents
Table of Contents........................................................................................................................................2
Introduction................................................................................................................................................3
(a) The comparative statement of two countries in context of effective monetary policy to control
inflation..................................................................................................................................................3
(b) Explanation about the factors that impeded the policy implementation in case of UK.....................5
(c) Evaluation of utilization of Fiscal policy during Financial crisis (of 2008-09) by Sweden and
United Kingdom....................................................................................................................................6
(d)Evaluation which of two countries was more successful in minimizing the potential negative
effects of recession.................................................................................................................................8
Conclusion..................................................................................................................................................8
References..................................................................................................................................................9
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Introduction
Inflation Targeting as the monetary policy tool with the involvement of central bank of
country, where the central bank set some rules and regulations regarding the inflation rate as its
objectives (Caputo, Leyva and Pedersen, 2014). It is used to create the right economic situation
to create rising prices. For this the inflation targeting uses to solve it. The central government
spurs economic growth by providing liquidity, credit and jobs opportunities in the economy.
(a) The comparative statement of two countries in context of effective monetary policy to
control inflation
In case of Sweden
Inflation targeting used as monetary policy in Sweden to control the problem of inflation.
The effect of adopting the inflation targeting the Sweden enjoys three benefits after
implementation that are first, the inflation targeting reduces the inflation and makes inflation less
volatile. Second, the inflation targeting reduces the real cost of disinflation and the third is
creation of new employment opportunities. It helps in context of stabilize both inflation around
low rate and resources utilization around the highest sustainable level. For this, the federal bank
and Riksbank are both involved in it. Both these banks played dominant role in controlling the
inflation by adopting the inflation targeting as monetary policy tool. The Federal Reserve has
dual objective of creation of employment opportunities and stable prices implemented for
stabilized inflation. Along with the stable inflation rate and stabilize employment around highest
sustainability among employment rate (Bernanke, B.S, et. al, 2018). Maximum employment
opportunity leads to highest sustainability in employment rate. The Riksbank’s main target is to
stabilize inflation by implementing inflation targeting and utilization for great sustainability
level (Davis, 2014). The Riksbank forecasts the inflation. The Riksbank stabilizes the inflation
around inflation target and stabilize the production and employment in long term sustainability
paths and Riksbank mandate the constant the issues of European system of central banks, that is
useful in price stability which is the primary objective of the Riksbank. However, no deviation
between the Riksbank hierarchical and the Federal Reserve bank’s dual objectives, the explicit
inflation target, inflation rate at that time was 2% per year and is enforced by Riksbank of
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Sweden (Baxa, Plašil and Vašíček, 2015). No explicit target is selected for the resource
utilization as its main drawback.
(Source: Sweden: Inflation Rate Is Close To The 2% Target, 2018)
From above graphical representation it is clear that the bank was able to reaching the inflation
target by using monetary policy as its instrument. It reaches almost near the target 2%.
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Illustration 1: Inflation targeting outcomes

In case of United Kingdom
In case of UK, the bank of England plays integral part in solving the situation of inflation
in country, the central bank of London as its primary objective to use the government inflation
target. In 1997, the government set the inflation target of CPI 2%. it means the bank wants to
keep the inflation in 1-3%. In UK the monetary policy implemented monetary policy committee
(MPC) which is the part of Independent Bank of England. By using the MPC under this interest
rate uses to achieve the goal of controlling the inflation (Leeper and Leith, 2016). In case the
inflation is above the inflation target, the MPC decides the increment in interest rate. The higher
interest rate means the cost of borrowing is cost of borrowing is higher and reduces the customer
spending and investment. It leads to low growth in AD and lower inflation (Gillitzer and Simon,
2015). In the situation of inflation, the low economic growth after the implementation of MPC
and it reduces the interest rate and stimulate AD.
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Text 1: presentation of U.K inflation rates targeting

From above graphical representation it is clearly understandable that how rates increased year by
year and after using monetary policy as a tool these are decreased and reached to the target.
Moreover, the ECB has target to maintain the inflation rate below the 2%. The UK
economy suffers from the “Boom and Bust” economic cycles. Moreover, the UK experienced
the cost push inflation of 5% due to increase in prices of oil (Nguyen, 2017). In order to
maintain the inflation rate at 2% and increase the growth rate the bank of England allowed the
interest rate to increase above the target because the inflation was temporary and recession was
stable. Not only this, the ECB increases the interest rate, despite low growth rate and consists
with deflationary pressure. The ECB sets the monetary policy to maintain the inflation in
Eurozone, as by targeting the inflation leads to costs of rising unemployment. The ECB is
unconcerned about the Eurozone’s slide as in case of double dip recession instead of preventing
prolonged slump they fixated the low inflation impotencies (El-Shagi and Giesen, 2013). The
inflation, if above can impose the costs on economy such as uncertainty, but these costs are less
than social and economic costs of mass employment. Unemployment in UK reached by 25%,
but there was little monetary stimulates in Eurozone because the ECB leads inflation at 2.6%
this reduces the inflation in minor context of recession (Andersson and Jonung, 2017).
The above explanation depicts that the Sweden had achieved better results in controlling
the inflation by using the Inflation targeting as monetary policy tool.
(b) Explanation about the factors that impeded the policy implementation in case of UK
In case of UK, Inflation targeting used as monetary policy to reduces or remove the
inflation rate and its affects. MPC uses the interest rate used to solve the problem. In prior era of
implementation, the MPC predicts the future inflation and used various statistical tools to control
the inflation. If the prediction declares rise in inflation rate (more than 2%), then MPC increases
the interest rates. The increment in interest rates leads to reduction in demand of the economy
and also leads to very slower growth (fluctuations in very slow growing rate) of economy
instead of steady economy growth (growth with same growing rate) (Neuenkirch and Tillmann,
2014). Impacts of increment in interest rates are as follows.
 Increased rates lead to increment in borrowing costs, discouraging consumer borrowing
and their spending.
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 Increased rates ensure increment in savings of money.
 It leads to reduction in disposable income with mortgages.
There are some reasons that impeded the implementation of the policy which are as follows.
 MPC becomes ineffective in maintaining steady rate of growth: Increment in interest
rates and results in cost of borrowings and reduces spending this was beneficial in
creating lower inflation but it drastically affects the economic growth and leads to heavy
downfall.
MPC fails in reduction of unemployment rate: Increment in interest rates affects the business
expansions as due increased cost of borrowings, this all were not helpful in creation of
employment opportunities or reduction in unemployment rate of UK (Creel and Hubert, 2015).
(c) Evaluation of utilization of Fiscal policy during Financial crisis (of 2008-09) by Sweden
and United Kingdom
Fiscal policy used by Sweden
During the financial crisis of 2008-09, Swedish government targeted the budget surplus
of one percent of GDP over the business cycle, as the main fiscal target (Cloyne, J., & Hürtgen,
2016). This target is examined by three intentions which are as follows.
 Ascertainment of assumable development of expenditures and taxes.
 Sustainability of public finance in long run.
 Equal distribution of fiscal resources across generations.
For analyzing the performance of economy against surplus target three indicators were used,
which are as follows.
 Average net lending from year 2005 concerted with information regarding the estimated
output gap over the same period.
 Average net lending of seven years, including three net years, three premature years and
one current year.
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 Prepared structural balance which attuned net lending, attuned for one-off and
temporary effects.
From above graphical representation it is clear that the Sweden use its fiscal policy by
using export import trend. Because in Sweden it is the major source of earning. So by this way it
also utilizes its fiscal policy to target inflation rate.
Moreover, the framework is based on midterm budget surplus targeting with multiple
year expenditure ceilings and up-down budgeting process (Bordo and Orphanides, 2013). This
framework was used as the response of crisis of 2008-09. for this, the expenditure ceilings were
used to support the surplus target and prevent of impermanent revenue for meeting the finance
permanent expenditure. The target helped to meet the net lending such as, average rate was 1.4%
of GDP (as above target) from year 2005 to 2012. Average value of net lending since 2005 has
exceed 1% since 2012. and seven years moving average indicator has been close to or above 1%
since 2003. the government gross debt had declined almost 85% of GDP in 2008 to about 47%
the GDP of 2012. Thus the net lending had been reinforced through flourishing expenditure
constraint rather than higher taxes. The fiscal policy council had prepared the framework in
order to meet the target of fair international income distribution and maintains fiscal
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sustainability for long term. Fiscal sustainability express that “current tax and spending policy
settings can rest unaltered in the future without making increment in government debt”. It
depicts that the government debt remained stable as proportion of GDP in long run (Yoshino and
Taghizadeh Hesary, 2014). As a result, this framework has restricted the automatic and
discretionary fiscal response during the crisis of 2008-09.
Fiscal policy used by United Kingdom
In UK, during the financial crisis the Bradford and Bingley building society was
effectively nationalized in late 2008 and after that partly sold to Spanish Group Santander Bank.
The UK government efficaciously forced the UK's largest mortgage lender, Halifax Bank of
Scotland(HBOS) etc. were in deep trouble and other UK banks like Barclays and HSBC, were
forced to raise capital by new issue of shares as due to Rise interest rates the cost of borrowings
increases it affects the profitability (Mahadeva and Sterne, 2012). Along with this, in UK retail
sales, furnishing and DIY sectors suffered from large falls. The businesses were suffered from
great fall in sales and profitability and due to lack of bank support for running the trade. Various
well-known brands were going out of their businesses. In fourth quarter of 2008, UK Gross
Domestic Product(GDP) fell by 1.5% and recession continued through 2009. it affects the GDP
growth in 0.3%, of UK in the beginning of crisis era. Not only this, the unemployment rate was
tending to increase by 7% and increase with last more than four years. The fiscal policy
framework was designed by the government council and give great respond to the financial
crisis by reducing the interest rates and cost of borrowing this reduces the industrial falls and
promote businesses again (Gerlach and Tillmann, 2012).
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(d)Evaluation which of two countries was more successful in minimizing the potential
negative effects of recession
As the above study depicts that the both of countries and their government adapts the
potential ways to minimize the effects of the financial crisis according to their own ways to
respond the financial crisis (Willard, L. B. (2012). As on one hand, the Fiscal policy adopts by
Sweden. The target helped to meet the net lending such as, average rate was 1.4% of GDP (as
above target) from year 2005 to 2012. the average value of net lending since 2005 has exceed
1% since 2012. and seven years moving average indicator has been close to or above 1% since
2003. the government gross debt had declined almost 85% of GDP in 2008 to about 47% the
GDP of 2012.these all were analyzed and their affects were reduced with help of fiscal policy
effective measures. On the other hand, UK Gross Domestic Product(GDP) fell by 1.5% and
recession continued through 2009. it affects the GDP growth in 0.3%, of UK in the beginning of
crisis era (Vega and Winkelried, 2012). Not only this, the unemployment rate was tending to
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increase by 7% and increase with last more than four years. The Central Bank of England
removes the MPC, which results in reduction of interest rates and exchange rates, it leads to
reduction in costs of borrowings and promoting the import and export of the country.
Conclusion
From the above study it has been concluded that the inflation is not good for the
development of the economy of country and it is inevitable to control and reduce its affects. as in
case of Sweden and United Kingdom, the inflation rises above inflation target and for solving
this problem both the countries uses inflation targeting as the monetary policy tool to control
inflation. In Sweden, the Riksbank performs major function in order to minimize the effects of
inflation and in UK the Central bank of England performs major functions for overcoming from
the inflation but, the central bank of England focuses only on adjustment of interest, while the
Riksbank focuses minimising the interest rates as well as promotes employment and Ensures
stable exchange rates with international trading partner countries. it helps the Sweden
government to response the inflation in more appropriate manner quickly.
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References
Andersson, F. N., & Jonung, L. (2017). How Tolerant Should Inflation-Targeting Central Banks
Be? Selecting the Proper Tolerance Band–Lessons from Sweden. Lund University
Department of Economics Working Papers, 2017(2).
Baxa, J., Plašil, M., & Vašíček, B. (2015). Changes in inflation dynamics under inflation
targeting? Evidence from Central European countries. Economic Modelling, 44, 116-130.
Bernanke, B. S., Laubach, T., Mishkin, F. S., & Posen, A. S. (2018). Inflation targeting: lessons
from the international experience. Princeton University Press.
Caputo, R., Leyva, G., & Pedersen, M. (2014). The Changing Nature of Real Exchange Rate
Fluctuations. New Evidence for Inflation-Targeting Countries (No. 730). Central Bank
of Chile.
Gillitzer, C., & Simon, J. (2015). Inflation Targeting: A Victim of Its Own
Success?. International Journal of Central Banking, 11(4), 259-287.
Nguyen, A. D. M. (2017). UK Monetary Policy under Inflation Targeting (No. 41). Bank of
Lithuania.
Vega, M., & Winkelried, D. (2012). Inflation targeting and inflation behaviour: a successful
story?.
Hüfner, F. (2012). Foreign exchange intervention as a monetary policy instrument: Evidence for
inflation targeting countries (Vol. 23). Springer Science & Business Media.
Willard, L. B. (2012). Does inflation targeting matter? A reassessment. Applied Economics,
44(17), 2231-2244.
Gerlach, S., & Tillmann, P. (2012). Inflation targeting and inflation persistence in Asia–Pacific.
Journal of Asian Economics, 23(4), 360-373.
Mahadeva, L., & Sterne, G. (2012). Monetary policy frameworks in a global context. Routledge.
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