Dear friends this is an analysis of a case study, of UK’s 1980s and 1990s economic status. The analysis is done in a question and answer form which makes it very easy to understand. And I have almost defined the economic terms and terminology related to this study.
What do you think is meant by a soft landing in the context of economic activity?
Well, the soft landing is a situation in which the economy, or part of it, slows down gradually after a period when it has been growing rapidly, without causing many problems.
What evidence can you find in the report to support the prediction of a soft landing?
Well, in my view the following are some of the strong supporting reasons for the prediction of a soft landing and I feel that they all contribute to the same trend. As I have already mentioned that soft landing does not harm much the economic condition of a country but still it can be a threat or wake up call for a country’s economy. They are as follows;
Ø Slowing growth of over all economy is generally a major sign of a soft landing.
Ø Modest retail sales growth. Inflation is causing the growth of the retails.
Ø The housing market remains subdue. It is mentioned in the case that the house prices are remained flatten in some areas and falling in others, so this point can also contribute to the soft landing, because the housing market is one of the most important part of economy.
Ø The strong recovery in the manufacturing sector over the past few years is now moderating. This is a very important point as it clearly says that after a strong recovery the manufacturing sector is now moderating, means not growing any more, so I am sure that this also indicates soft landing.
Ø PSBR position during the financial year is slightly worsening and the downward trend is expected to continue. This is very important point as we know if a country’s PSBR (public sector borrowing requirement) is worsening and tend to continue so it is obvious that a country is facing a slight budget deficit and would face a soft landing in economy.
Ø The export rate is slowing, which is reflecting in over all slowdown in growth. Export is also a main source of income which in this case is getting slow.
Ø The 4% economic growth of the last year has come down to 3% of GDP and will be just over 3% this year and is also likely to come a little bit more down from 3%, is clearly supporting the expectation of a soft landing.
The UK experienced a severe boom and bust cycle in the late 1980s and early 1990s, what were the main causes of such volatile activity? What were the main consequences for economy for economic policy?
Boom and bust is a feature of an economic system or an industry where a period of success and wealth is followed by a period of difficulty, then by another period of success, and so on in a repeated pattern:
The sharp rise in the export volume relative to import has helped a lot UK’s economy to stabilize as well as grow because when export is more than import the products go out and in return money comes in, on which profit is made and the same money is reinvested so it gets multiplied.
Not to increase the interest rate has also helped the country’s economy. The low interest rate encourages people to borrow more money, for their activities like investing in various businesses and as well as spending on various commodities. These all activities increase the flow of the money and the economy grows very rapidly.
On the other hand high rates of interest are reducing borrowing and it subsequently results in reduction of investment and consumption rate. The most important element of an economy success of a country is confidence of the people if the confidence of the people is low then the investors as well as the consumers’ setback and reduces their activities in the market.
When there is a rise in income the economy can be recovered, because people will spend, save and invest while their income is high, which in UK happened during that time of boom and the opposite is but when income is low and now spending, saving and investment is done.
Monetary policy plays a major rule over here. If it does not consider the cost of money and availability of money properly then it can affect the entire economy such as housing sector, business investment, spending on consumer durables, export. These all things are influenced by interest rates, credit availability and foreign exchange rate.
Note; I have given some more details at the end of the report regarding overall condition of the UK’s economy.
Monetary policy has tended to emphasize small changes in short-term interest rates in recent. Explain the rational behind this policy and compare it with interest rate policy decisions in the 1980s.
Monetary policy is the way in which a government or central bank controls the supply of money and credit in an economy; Demand can be stimulated by the proper mix of fiscal and monetary policy.
The purpose behind monetary policy and its ultimate objectives are to achieve the best combination of low inflation, low unemployment, rapid GDP growth and orderly financial markets. The changes in the interest rate were aimed to encourage people to take actively part in their businesses, so that the economy could grow fast. If the government puts a high rate of interest rates people will not borrow money from the financial market and in return the financial market will not be getting any interest and finally the economy will worsen.
As we have know that investment, saving, spending, and employment give potential growth to the economy, so it is important to encourage the people by giving them some incentives (like low interest rates, low taxes rates). Changing in interest rates has a great influence up on the housing, mortgage, business investments, stock prices, spending on consumer durable, state and local spending and export sectors. The interest rates can slam and raise all the mentioned sectors immensely.
Why is the continued fragile state of the housing market regarded as an important factor with respect to consumers’ expenditure and the general feel-good factor?
Well, housing market is an important market due to the following reasons;
Ø This sector involves high business transactions. It is major business market in terms of consumers’ spending (expenditures).
Ø It provides interests to the financial market as people borrow money for the purpose of buying, and constructing houses, so it has a great effect on the economy.
Ø It provides jobs to the people both in financial markets as well as engineers, architectures, labors etc, as they construct and build new buildings and in return they make money through this business.
Ø It provides property taxes to the government, taxes are very important to the government for the development of developmental and non-developmental expenditures.
Ø It shows the interest and confidence of the people in the country’s economy if no confidence then no growth, because people are risk-averse, they try to avoid loss and save themselves safe.
Ø This sector (housing market) stabilizes almost the financial market as it is a huge element of consumers spending.
Why should the financial markets be concerned about the government’s budget deficit position?
Financial market has the functions of buying and selling shares, bonds, currencies, etc.
Budget is the official statement made by a government of the country’s income from taxes, etc. and how it will be spent. And budget deficit means when there is a short fall in the budget.
Now coming to the financial market concerns, why is the financial market concern about the government’s budget deficit? It is very clear that the government as a watchdog always has the duty to regulate, control and even help all the sectors in a country. As financial market a part of business sectors, it should be concerned about the budget deficit.
Any decision made by the government has the impact on all the sectors in the country. And if government faces any difficulty it also has an adverse effect up on all the sectors. Because the government can not fulfill what he has planed for the country’s economy, so he has to borrow form somewhere else which in return require interests which can really cause the economy.
So for paying all those interests and debt the government is obliged to increase the interest rates in the country for its loans and apply a high rate of taxes and cut subsidies given to some of the companies.
Here the government will have to tighten the fiscal and monetary policies in order to make sure; the flow money, cost of money, price stability, exchange rate stability, taxation, borrowing and many other economic activities which in these all activities the financial market is interested and has a close relationship with it.
If all these activities were enjoyable the financial market will be happy otherwise it goes sick. Because the government will not have enough money to inject it to the market in order to stabilize the market and its flow. So the financial market will suffer a lot that is why financial market is concerned in the government budget deficit.
How supply-side policies have changes the UK’s economic performance in recent years?
In my point of view the economic performance of UK was indeed caused by the reforms, particularly the reform of the industrial relations system or to put it more frankly, the reduction in union power. For better clarification the following are some of the real facts of the supply-side policies changes and their impacts and advantages.
Supply side Policies in the UK during 1980s and 1990s
· There has been an extensive privatization campaign; most of the major utilities such as Gas, Water and Electricity have been sold by the govt.
· Generally this has been successful more competition, lower prices and better quality of service.
· However it has been difficult to introduce competition into the water industry and Railway industry.
2. Tax Cuts
· In the 1980s income tax was cut especially for the better off, the top rate of income tax fell from 60% to 40%. This did not lead to significant increases in productivity. Overall the tax burden has not fallen because the government has increase indirect taxes
3. Reduced Power of Trades Unions
· The power of trades unions has fallen because of laws making it more difficult for unions to operate. Also the decline of manufacturing industries has reduced an important trade’s union base. There are now less days lost to strikes and wage inflation has not been a problem like in the 1970s
· However many workers are less protected and may get lower wages leading to greater inequality
4. Deregulated Financial Markets
· The government has deregulated the financial services market, for example building societies can act like banks, and more institutions can now offer mortgages, this has lead to more competition and lower borrowing costs for many
5. Other Factors that Have increased Productivity in UK economy
· However increased productivity is not just due to govt. supply side policies. Other factors have also caused increased productivity like;
· Better technology. The development of the internet has helped reduce costs for firms and increase competition; this is not due to the govt.
· Lower prices of raw materials. In the past decade the price of raw commodities have stayed fairly low, this has helped keep inflation low
· Increased inward investment, Foreign companies have often been successful in implementing better working conditions
Overall view of the UK’s Economy;
The cut in the interest rates is playing a major role because this can attract people to borrow and invest in the markets, especially in the housing market in which all the common people get involved. Stocks rise in the hope of interest-rate cuts.
Investment is a major function of an economy which subsequently results to continue the cycle of business and multiply the productivity rate of all other functions of economy (employment, consumption, savings, aggregate demand, and aggregate supply).
People are always afraid of high rates of interest as well as high rates of taxes. That is why business people don’t have the incentives to invest and when there is no investment, then everything gets stopped. Rate of the unemployment decline has continued to moderate and has come down. Much of the improvement is in large measure due to an increase in part-time employment and a decline in the number of people registering for unemployment benefits. Employment plays a great role in the smooth running of economy.
At the end of the 1980s, when the economy was at the peak of the cycle, the fiscal surpluses gave a misleading picture of the health of the public finances. However, fiscal policy was relaxed. Output, revenue and spending projections, and, in particular, the estimate of the level of output relative to its trend, were subject to large errors. The fiscal position turned out much worse than the forecasts and illustrative projections suggested. As the 1980s progressed, the PSBR declined and surpluses were reached. On the basis of unchanged policies, surpluses were projected to continue.
But by the early 1990s the public finances had deteriorated markedly with the deficit reaching 7 per cent of GDP in 1993-94. The cost of this deterioration has been high.
At the end of the 1980s the fiscal surpluses were taken largely at face value and so gave a misleading picture of the health of the public finances.
The UK was only able to repay part of its public debt because output was significantly above its trend level. Over optimism about the trend level of output at the end of the 1980s was a critical factor for the deterioration of the public finances over the last cycle. Finally, the two components of the fiscal balance - revenues and expenditures - are in themselves difficult to forecast with accuracy.
The experience of fiscal policy over the last economic cycle demonstrates that it is easier to reduce revenue and increase expenditure than to do the reverse. So when things go wrong with the public finances it is difficult to put them right, particularly since it can take a long time even to recognize the problem. Moreover, when public borrowing turns out higher than expected, debt interest costs also rising intensifying the problem.
The Government has set the following two fiscal rules which deliberately take account of the significant effect of cyclical variations on the public finances: The golden rule: over the economic cycle, the Government will borrow only to invest and not to fund current expenditure; and Public debt as a proportion of national income will be held over the economic cycle at a stable and prudent level.
The Government's commitment to transparency and stability, and to achieving its fiscal rules, will form key features of the proposed Code for Fiscal Stability.
For better understanding the following charts are supplemented; they represent the various aspects of UK’s economy status.
Many business cycles occur when shifts in aggregate demand cause sharp changes in output, employment and prices. Aggregate demand shifts when changes in spending by consumers, businesses or government change total spending relative to the economy’s productive capacity. A decline in aggregate demand leads to recessions or depressions. And an upturn in economic activity can lead to inflation.
Business cycle is influenced by exogenous factors such as technology, election wars, exchange rate movements, or oil price shocks. Insufficient aggregate demand leads to deteriorating business conditions and soaring unemployment. Understanding the forces that affect aggregate demand, including government fiscal and monetary policies can help to smooth out the cycle of boom and bust.
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Dear friends this is an analysis of a case study, of UK’s 1980s and 1990s economic status. The analysis is done in a question and answer for...