ECO 4012: Evaluating Government Macroeconomic Policies in the UK

This report, focusing on the principles and applications of macroeconomics, evaluates the success of UK government macroeconomic policies in achieving lower unemployment rates and reduced inflation over the past decade. It explores various strategies, including monetary policy (interest rate adjustments and quantitative easing), fiscal policy (tax cuts and government spending), and exchange rate policies. The report analyzes the advantages and disadvantages of each policy, particularly in the context of the UK's economic structure. It also examines the impact of Brexit on the exchange rate and its subsequent effects on unemployment and inflation. The report highlights key challenges, such as hindering economic growth and the risks of recession and depression, while providing a comprehensive overview of macroeconomic policy implementation and effectiveness. The analysis covers the period from 2014 to 2024, addressing the UK's specific economic conditions and policy responses.

Module Code: ECO 4012
Module Title: Principles and Applications of
Macroeconomics
Topic: Evaluate the success of Government macroeconomic
Policies to achieve both lower levels of Unemployment and
lower rates of Inflation over the last 10 years.
Student Name:
Student ID:
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Table of Contents
Introduction......................................................................................................................................3
Macroeconomic policies to reduce the unemployment rate and inflation.......................................3
Reducing unemployment rate..........................................................................................................4
Monetary policy...........................................................................................................................4
Fiscal policy.................................................................................................................................5
Depreciation of exchange rates (Exchange rate policy)..............................................................7
Decreasing the inflation rate............................................................................................................9
Monetary Policy...........................................................................................................................9
Fiscal policy...............................................................................................................................10
High exchange rate....................................................................................................................11
Advantages and disadvantages of the policies...............................................................................11
Monetary....................................................................................................................................11
Fiscal policy...............................................................................................................................12
Exchange rate policy..................................................................................................................12
Key challenges and suggestions....................................................................................................13
Hindering the growth.................................................................................................................13
Recession and depression..........................................................................................................13
Conclusion.....................................................................................................................................13
References......................................................................................................................................15
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Introduction
Macroeconomic policies are used by governments to create a stable economic environment for
long-lasting growth in the economy. Macroeconomics enables a country to understand its entire
economic function and national income (Agénor and Montiel, 2015). Macroeconomics assists to
achieve targeted GDP and economic growth. Macroeconomic policies are important to have a
stable price level in a country’s economy. If a country falls into an economic crisis like poverty,
unemployment, inflation, etc. macroeconomic policies are usually used to find appropriate
solutions to those problems and get out of them as soon as possible. Without macroeconomic
policies, a country cannot stay stable for a long time.
The unemployment rate shows how the economic health of a country is going by. When a
countries GDP increases, the unemployment rate decreases. THE highest GDP means the income
rate is also high as well as higher industrial production. Governments use macroeconomic policy
like fiscal policy or monetary policy to achieve this success. When using expansionary fiscal
policy changes have to be made in spending and taxes to shift the aggregate demand to a more
outward position. In the case of contractionary fiscal policy, the changes in spending and taxes
are made to shift the aggregate demand inward. If the unemployment rate is going lower than
average that means the economy is growing substantially. This might cause inflation if not
controlled. If the unemployment rate is at a higher point than average then it means income and
stocks are going down (Blanchard et al., 2010).
This report explains what macroeconomic policies are and why they are important for the
economy of any country. The purpose of this report is to give a brief explanation of what
macroeconomic policies to adapt to get make the unemployment rate lower and reduce the
inflation rate. The advantages and disadvantages of those policies are discussed as well as
identifying key challenges of applying those policies in an economic system.
Macroeconomic policies to reduce the unemployment rate and
inflation
There are more than few policies to adapt when it comes to reducing unemployment. But for this
report, 3 policies from the demand side are taken. Those policies are monetary policy, fiscal
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policy, and depreciation of the exchange rate. These policies can also be used to reduce inflation.
And these policies are going to be described in the context of the United Kingdom’s economic
structure and system.
Reducing unemployment rate
Figure 1: Macroeconomic policies to decrease the unemployment rate
Source: (Bernanke, 2020)
Monetary policy
In monetary policy, governments would have to cut down the interest rate. By doing so it enables
people to borrow money from the government and spend and invest more. As a result, aggregate
demand increases, and GDP increases. The United Kingdom has a committee for maintaining its
monetary policy. This committee is called the ‘Monetary Policy Committee’. This committee
consists of 9 members. They hold meetings among themselves and decide what steps to take and
what went wrong in terms of the economy. Currently, MPC has set the standard interest rate for
banks in the UK to 0.1%. By keeping this low interest rate, the UK can keep the exchange rate
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reduced and make the exporting sector more competitive. Sometimes even a lower interest rate
might still not encourage people to invest more (Bernanke, 2020). In that case, central banks use
Quantitative easing. In this policy, the banks increase the supply of money in an attempt to
increase aggregate demand. The Bank of England used this policy in 2009. The Bank of England
is also responsible for setting these interest rates. If they want to reduce unemployment then they
cut the basic interest rate. In theory, having a lower interest rate can increase economic activity.
If the economic activity exceeds the bank’s expectation and the bank feels it cannot control it
anymore then it increases the interest rate to reduce economic activities. By using this changing
Loose and Tight Monetary Policy the Bank of England usually controlled the unemployment
rates in the past 10 years and so on. But other elements of aggregate demand might influence the
unemployment rate too. Some banks might refuse to agree with the lower interest rate as this
might hamper their business significantly (Rostagno et al., 2019).
Fiscal policy
In order to decrease unemployment, governments have to use expansionary fiscal policy. For this
policy to come into effect, the government has to cut down taxes and invest heavily by
themselves. This decreased tax will bring more disposable income for the people and they will
create a habit of consuming more goods. This will increase the aggregate demand of the country.
After the aggregate demand increases, the GDP of the country will also increase. As there will be
more overall demand then factories and firms will have to produce more products for this
increasing demand. They will have to hire more employees to meet this increased demand. Also
by having created this much economic growth, firms are less likely to lose money and go
bankrupt, and vacant more jobs (Mankiw, 2013).
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Figure 2: Impact of higher aggregate demand on economy.
Source: (Chugunov and Pasichnyi, 2018)
The United Kingdom has a fiscal policy. It also is designed in a way to make the unemployment
rate lower. The United Kingdom has an expenditure for unemployment benefits. This is a
separate program within the fiscal policy that the government provides by having a different
section of tax money kept differently to use for the purpose of reducing the unemployment rate
when it is needed (Arestis and Sawyer, 2013).
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Figure 3: Expenditure for unemployment benefits in the United Kingdom.
Source: (Kolb, 2010)
But there are some setbacks to fiscal policies too. There is no guarantee that people will spend
more if taxes are cut. Some of them might want to save it too. Fiscal policy is a time-consuming
policy. It might not show the expected result by the time it was expected.
Depreciation of exchange rates (Exchange rate policy)
If a country is facing depreciation, then that country’s exchange rate of money will go down. As
a result, exporting things to foreign markets will bring less money, and importing goods from the
foreign market will become more expensive. For example, if the British pound’s exchange rate
depreciates then buying goods from the UK would be cheaper for other countries, and bringing
goods from other countries will become more expensive. So naturally, other countries will try to
benefit from this factor. So the number of imports will get higher progressively. Local firms will
seize this opportunity to export more goods to the foreign market. This will create new jobs and
decrease the unemployment rate (Cugat, 2019).
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Figure 4: Effect of devaluation
Source: (Blanchard et al., 2010)
In 2020 the United Kingdom got out of the European Union. This was a significant event in the
political history of Europe. This exit from European Union was called Brexit. The economic
impact of Brexit was also significant. As a result of Brexit, the exchange rate of the British
pound dropped quite a bit. This meant a depreciation of the exchange rate. As a result, the United
Kingdom faced major blows in the importing industry. But the unemployment rate of the United
Kingdom was also recorded low in that year. It can be assumed that the event follows the theory
stated above. As the United Kingdom got out, their money’s worth dropped and other countries
tried to buy goods from the UK at a cheaper price thus resulting in creating new jobs that were
not available before (Dvoskin et al., 2020).
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Decreasing the inflation rate
The same policies that were used to reduce the unemployment rate can be used to decrease the
inflation rate. The inflation rate of the United Kingdom has been quite stable over the years. This
graphical presentation depicts that information better.
Figure 5: The United Kingdom’s inflation rate over the years
Source: (Cugat, 2019)
Monetary Policy
Monetary policy is the most important policy in order to obtain a low inflation rate. Countries
like the United States and The United Kingdom use monetary policy to maintain their inflation
rate at a controllable rate. The United Kingdom has set a target of having an inflation rate of 2%.
In the United Kingdom the inflation rate and interest rate is set by the Monetary Policy
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Committee of The Bank of England. The MPC begins its operation by predicting a future
inflation rate. They look at various factors and statistics that might affect the inflation rate in the
future. If they find out that the economy is booming without their control then they will increase
the interest rate in order to discourage consumers from borrowing (Elson and Cagatay, 2012).
When the MPC sees that the inflation rate is well under the desired target, they decrease the
interest rate. This encourages the consumers to borrow more money, spend more money, and
consume more goods. This puts the economy of the country is a booming situation. But
overheating the economy could also be an issue for the Bank of England. As the MPC already
has a target of having an inflation rate of 2%, they set their interest rate at 0.1%. This gives them
enough opportunity to observe how the economy behaves under different situations and different
factors. Having a stable interest rate and inflation rate encourages the consumers to keep their
consumption of goods and savings in a balanced state. The main objective of all this process is to
avoid recession. By using both tight and loose monetary policies, the Bank of England keeps the
economic situation of the country in a state of balance (Cloyne et al., 2018).
Fiscal policy
Quite opposite to the way of keeping the unemployment rate low, the government of the United
Kingdom increases tax rate and reduces expenditure to keep inflation low. This can go both ways
depending on what the government wants to achieve. By increasing the tax rate and reducing
expenses the government can divert the consumers from consuming without control. Also by
decreasing the tax rate and increasing the government expenses would enable the consumers to
consume more goods and help the economy to boom faster (Bhattarai and Trzeciakiewicz, 2017).
All these factors are essential to control the inflation rate. The United Kingdom has a target
inflation rate of 2%. They have been decreasing their expenses towards unemployment gradually
for the last 10-15 years. This only indicates that their inflation rate is lower than the targeted and
they will reduce the amount expenses until they meet their targeted inflation rate. Having a stable
inflation rate is important for a country’s economy. Too much inflation is bad for the economy.
Too little of it can also hurt badly. Increasing the taxes can be risky. Because people do not like
it when they have to pay higher taxes than other countries with the similar economy. And
limiting the government expenses is not that popular among the general people either. This
makes this policy a non-popular policy to follow. But extreme situations can force the
government to resort to this policy once in a while (Kolb, 2010).
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High exchange rate
The government uses this policy to keep the value of their money relatively higher than other
countries. This involves determining an exchange rate policy and conducting foreign exchange
by following that policy. By having a higher exchange rate a country can achieve a lower
inflation rate. When a country’s monetary exchange rate is higher than standard then importing
anything for that country becomes much cheaper as their money has a higher value than others.
But exporting goods to other countries becomes expensive for other countries (Cugat, 2019).
They usually don’t want to buy goods at a much higher rate when they have cheaper alternatives.
As a result, the country could lower the inflation rate significantly. But that might decrease the
GDP and increase the unemployment rate. The United Kingdom followed this policy in 1980.
They joined the ERM in 1980 to control inflation. They kept the exchange rate of the British
pound relatively higher. They managed to gain all the objectives that they targeted initially. They
increased the interest rate by 15%. That was a bold move by the government which eventually
led to recession. The United Kingdom has never tried this policy ever since (Blanchard et al.,
2010).
Advantages and disadvantages of the policies
Monetary
Advantages Disadvantages
Monetary policy can implement the changes
faster. It is a speedy policy which can put its
effect as soon as possible. The decision of
making changes to monetary policy can be
taken in days and the effects of this policy can
be seen in less than a month.
Monetary policy does not assure economic
recovery. During the recession, consumers
will not have the confidence needed to spend
their money. Which means they will not take
advantage of the lower interest rates.
Monetary policy’s biggest advantage is that it
can keep the inflation rate stable. By using the
monetary policy properly, a government can
easily achieve a low inflation rate.
During global recessions, when the banks
lower the interest rate, the consumers will not
be confident to borrow the money and spend.
This will hurt the exporting industry in a big
way (Rostagno, 2019).
By using monetary policy the central bank or Even if the central bank declares about the
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the federal reserve can print more money.
Which can keep the interest rate low. And this
will also bring new borrowers of that money.
The inflation rate also stays low.
lower interest rate. Not all banks might have
enough funds to allow the consumers to
borrow a large amount of money at a lower
interest rate.
Fiscal policy
Advantages Disadvantages
Fiscal policy is one of the best policies to
reduce the unemployment rate of a country.
By changing the tax rates and expenditures
the government can create many production
processes and job chances.
The fiscal policy takes a long time to be
implemented. It takes a lot of days to come
with a perfect policy suitable to the country’s
economy than many more months even years
to be implemented properly.
If a country’s budget exceeds its income, then
the fiscal policy can help to balance that
budget by tweaking the expenditures and
taxes (Chugunov and Pasichnyi, 2018).
When using a mixture of contractionary and
expansionary fiscal policy, their objective
could contradict each other.
The fiscal policy helps the economy of a
country to grow to its full potential. By
reducing taxes, the government can encourage
individuals to take part in more economic
activities.
Fiscal policy is not a popular policy when it
comes to decreasing inflation. General people
do not feel comfortable with increasing the
taxes.
Exchange rate policy
Advantages Disadvantages
By having a fixed exchange rate, business
entities and firms can operate their business
with a lot more certainty and risk.
The exchange rate policy is subject to great
uncertainty. It can change anytime and it is
very hard to keep it fixed without having a
stable economic system.
By keeping the exchange rate high, the
government can keep the inflation rate
The higher exchange rate can cause a
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