In order to ensure the prosperity of the nation as well as the citizen's welfare, the country's government plays an important role. In this, the government develops long-term economic policies to facilitate economic growth. It is because the main emphasize of the government is to ensure economic growth in order to provide better life to the people (Pearson, 2000). The main purpose of this report is to discuss the ways, through which the government can use long term economic policies to facilitate economic growth. In addition to this, it also explains why and how the UK government could use fiscal and monetary policy to temporarily stimulate the UK economy. The paper also includes the use of AS and AD analysis for supporting the explanation.
Use of Long-term Economic Policies
In order to facilitate economic growth, the main long-term economic policies include either an increase in aggregate demand or total supply (Goggin and Hjorth, 2009). It can be explained that the use of demand side policies is effective during recession while supply side policies are useful for influencing long-term growth in productivity consequently facilitating economic growth (Harrison and Hart, 2002). Therefore, the use of supply side policies is discussed in this section for increasing economic growth.
It is evaluated that the use of supply side policies supports in increasing productivity as well as the economy's efficiency, thus these can be used by the government to improve economic growth (Harrison, 2016). For example, the government can reduce tax and also by investing in the human capital encourage entrepreneurship that could be beneficial to facilitate the economic growth. The below figure shows the changes in the supply curve due to the use of long-term economic policies:
Figure 1: Impact of Long-term Economic Polices
(Source: Anderton, 2000).
It can be interpreted from the above graph that as due to the use of long-run economic policies, real output increases from point A to point B, the supply curve shifts from LRAS1 to LRAS2 that is supportive to facilitate economic growth.
In addition, various individual actions can also be taken by the government to use long-term economic policies to improve economic growth. For example, in comparison of changing demand, the government can apply tax system for improving output resulting in facilitating growth (International Monetary Fund, 2001). In this, the government can cut direct taxes such as income tax and corporation tax to facilitate growth. For instance, when corporation tax will be lowered, it will encourage new businessmen to start out and improving the national output. Similarly, lower income tax will also influence both employed and unemployed workers to work effectively and contribute in the increasing GDP.
Moreover, the government can also increase the use of measures for bettering the mobility of labour as a part of long-run economic policies. For the reason, the implementation of such measures would be beneficial to improve overall productivity as well as output performance resulting in facilitating economic growth (Porter, 2000). In addition to this, it is also evaluated that the application of liberal supply side-economic policies could be supportive to preserve the economic growth.
At the same time, the government can also invest in human resource development to apply long-run economic policies for facilitating economic growth. For instance, the government can increase its expenditures on training and educational programs to support the growth of the economy (Cooper, Ronald J. Burke, 2011). Moreover, the government can also create standards for teaching so that performances can be monitored effectively. It would be beneficial to better skills as well as for the development of current knowledge level of individuals resulting in improving labour productivity and helping economic growth (Wilkinson, Bacon, Redman, and Snell, 2009).
At the same time, there are also other long-run economic supply-side policies such as investment tax credit and high tax on profits that are not invested and joined with general investment reserves with the use of marginal tax rate (Higson, 2011). The main focus of these policies is on the employment growth and control of public finance. Thus, to support economic growth, these policies can also be used by the government. Additionally, the government can also use deregulation, lower barriers on tariff, free labour and financial market, betterment of infrastructure, privatisation, and availability of information for facilitating growth of the economy (Jaffe, Newell, and Stavins, 2005).
For example, the UK government develops various long-term economic policies such as infrastructure policy, investment in science and technology policy, etc. for supporting the economic growth in the country (Arora and Gambardella, 2005). The main purpose of these policies is to help the people, who want to win as well as work hard. For instance, the government significantly invests (over £100bn) in the infrastructure policy so that the basic structure can be improved and economic growth can be supported (UK Government Policy Paper, 2015). This policy is beneficial for the betterment of sectors including science, energy, transport, communication, water, etc. Furthermore, the development of these sectors is supportive for the overall economic growth due to the growth of industrial sector, improved productivity, and increase in disposable income.
Concurrently, it is also evaluated that the government can also invest in research and development activities for facilitating innovative activities and supporting growth (Arora and Gambardella, 2005). Moreover, the government can also provide funds to the businesses and support small businessmen to implement long-term economic policies and facilitate economic growth (Wetzstein, 2013). In addition to this, the government can also focus on increasing export, cut taxes, simple business regulations, and the development of more educated and knowledgeable workforce for supporting the growth of the economy. For example, in the year 2015, the UK government reduced the corporation tax to 20% to contribute in the development of the economy by increasing business activities (UK Government Policy Paper, 2015).
Overall, it can be discussed that the government can apply long-term economic policies by increasing investment in education, labour market, cut taxes, and human resource development to facilitate growth of the economy.
Use of Fiscal and Monetary Policy
Meaning and Importance of Using Fiscal and Monetary Policy
Fiscal policy refers to the policy of government that affects total demand by changing the inflow (tax) and outflow (expenses) structure of the government budget (Anderton, 2000). The main purpose of fiscal policy is to correct a fundamental disequilibrium in the economy as well as to influence total supply so that the government's objective to maximize public welfare can be attained (Arnold, 2008). On the other hand, monetary policy also refers to the efforts of the government through its central bank to regulate the economic activity by controlling the money supply in terms of credit and currency (Pika, Maltese, and Rudalevige, 2016). Thus, it can be discussed that as the purpose of both fiscal and monetary policies is to preserve economic growth, these could be used by the UK government to temporarily stimulate the economic growth.
In addition, there are several reasons that demonstrate that the UK government should use monetary and fiscal policy to stimulate economic growth temporarily. In this, on the basis of arguments by John Maynard Keynes, it can be discussed that fiscal inputs are effective to induce economic growth. It is because as a decline in private demand for goods and services results in an economic decline, in this situation, the government efforts can stimulate the demand (Pika, Maltese, and Rudalevige, 2016). For example, through fiscal policy, the UK government can increase its expenditures or increase consumers expenditures by reducing taxes to stimulate growth. Furthermore, it would be beneficial to increase in consumer demand resulting in improving economic growth (Makki and Somwaru, 2004).
Moreover, the arguments by the Keynesian school clearly indicates that the use of fiscal policy can have strong effects on aggregate demand, employment, and output at a time when the economy is operating well below national full capacity output and where there is a requirement to provide a demand stimulus to the economy (Riley, 2004).Thus, on the basis of Keynesian's arguments, it can be discussed that the role of the government can be effective to stimulate the economic growth through the active use of fiscal policy. At the same time, monetarist economists also believe that fiscal policy effects such as changes in taxes and government expenditure can have a temporary effect on total demand and output (Wacziarg and Welch, 2008). Moreover, they also argued that monetary policy is a more effective and efficient tool for controlling demand and inflationary pressure.
The UK government can use fiscal policy through substantial increase in the government spending particularly on education, transport, infrastructure, healthcare, and welfare in order to stimulate the economic growth (Geyer, Mackintosh, and Lehmann, 2005). For example, during the period of 2001-2004, the UK government provide huge fiscal stimulus to the UK economy by increasing government spending or a rise of more than 34% on transport and health and education areas. The significant increase in government expenditures supported in maintaining UK's short-term economic growth at a time when some components of AD mainly investment and export demand have been week (Riley, 2004). Thus, it can be discussed that the use of fiscal policy by increasing government expenditures could be helpful for the UK government to stimulate growth in a temporarily manner.
In addition to this, the UK government can also use its tax instrument to stimulate the economic growth. It is because when the government cut in taxes such as on personal income, indirect tax, corporations tax, and on savings, it boosts to the disposable income and adds to consumer demand consequently inducing economic growth (Baumol and Blinder, 2008). The government uses tax instrument as a part of expansionary fiscal policy while government spending (reduce spending and increase taxes) as a part of contractionary fiscal policy to stimulate the growth (Gwartney, Stroup, Sobel, and Macpherson, 2008). The use expansionary fiscal policy to induce the economic growth can be effective only for a short-term period. It is because in the long-run, the growth can become unsustainable due to the reduction in cost through the collection of human capital. The following figure shows the changes in demand and supply due to the use of both these policies:
Figure 2: Manipulating Inflation and Growth to Change in demand and supply
(Source: Henderson, 2004).
It can be interpreted from the above figure that the use of fiscal policy changes the output level, price, and demand curve due to the changes in the tax and government spending. For example, due to cut in tax and increase spending, aggregate demand increases from AD0 to AD1 as a result of increase in price and output level (P2 and Y2). Similarly, supply curve shifts to AS1 from AS0 due to the increase in price and decrease in the output level as a result of increase in taxes and reduction in spending.
In addition to this, the UK government can also apply fiscal policy instruments such as automatic stabilizers and discretionary fiscal policy to temporary stimulate the growth of the economy. Automatic stabilizers denotes to the revenue and expenditure programs in the government budget, which adjust in an automatic manner with the increase or decrease of the economy for making stable the disposable income, consumption, and real GDP (McEachern, 2008). Similarly, the UK government can also apply automatic stabilizers in terms of income tax to stimulate the economic growth. It is because as once taxes are adopted, there is no requirement for any government action to activate, and at the same time, it also manages the ups and downs in the income and preserve the economic growth.
Moreover, the UK government can also use discretionary fiscal policy and can manipulate its purchase, transfer payments, and taxes to stimulate the economy's growth. In addition, the use of this instrument can also be supportive to attain other macroeconomic goals such as full employment and price stability (McEachern, 2011). Thus, it can be discussed that fiscal policy and its instruments can be used by the UK government for stimulating the UK economy.
Alike to fiscal policy, the main purpose of monetary policy is to stimulate the growth of the economy by controlling the money supply. It is also aimed to preserve real growth of the economy equals to the economic growth determined by environment, technology, and resources (Rabin, 2001). For the reason, if the real economic growth rate will be higher than the expected growth rate, it can cause inflation resulting in adversely affecting the economy. Interest rate, bank rates, and open market purchases are the main instruments that could be applied for controlling the money supply and stimulating the growth of the economy (Vasigh and Fleming, 2016).
Similarly, the UK government can lower interest rate through the Bank of England to apply the monetary policy to induce temporary economic growth. It is because decline in the interest rates would be beneficial to increase in disposable income due to the availability of affordable loans (Folsom and Boulware, 2014). It is evaluated that monetary authorities also cut interest rates to stimulate slow economies by increasing the money supply. On the other hand, it is also found that in the case when an economy is growing beyond optimum or maximum scale level, the application of monetary policy can adversely affects the economic growth resulting in affecting life of the people (Bishop, 2012). It is the reason that in such circumstances, the use of higher interest rates and tighter monetary policies is effective.
Moreover, many economists also believe about the limitations of monetary policy to stimulate temporarily economic growth (Peng, 2015). For the reason, it can result in high inflation in the country. For example, a simulative monetary policy can increase economic growth, but concurrently it could lead to demand-pull inflation. Similarly, the use of restrictive monetary policy has also possibility to reduce inflation as well as the economic growth (Madura, 2014). Thus, at the time of implementing monetary policy, it is essential to make a trade off to ensure the growth of the economy. But, at the same time, the use of fiscal policy can be effective to induce growth by keeping growth in total supply equal to growth in total demand.
In addition to this, the UK government can also reduce the bank fund rates as a part of monetary policy to temporary induce the economic growth. In this, the central bank can significantly lower the bank rate many times in a single year (Hudson, 2010). Additionally, the UK government can also use quantitative easing method to apply monetary policy for stimulating growth of the economy temporary (CTI Reviews, 2016). In the case, when interest rates cannot be lowered further, the use of quantitative easing method can be suitable. Under this method, different kinds of assets are purchased in a big quantity by the government to increase the money supply. This method was firstly adopted by the central bank of Japan as the bank purchased stock and treasury bills to stimulate the growth. In addition, there are other countries like China that used other methods such as decreasing loan rate, reducing deposits, and application of expansionary monetary policy to stimulate the economic growth (Hudson, 2010). Thus, the UK government can also use these methods to stimulate the growth in the UK economy.
Concurrently, the UK government could also use monetary policy to keep inflation low, enhance the confidence of the decision-makers, and increase investment in production capacity in order to stable the economic environment. Moreover, by building opportunities to better living standards, the economic growth can also be stimulated. For example, the following AD/AS graphs are drawn by considering the overall level of price:
Figure 2: AD/AS Graph
(Source: Smith, 2015).
In the above graphs, the point of initial equilibrium is at Y0, r0, and P0 indicating to the level of output, interest rate, and price level respectively. It also shows that it is important to create a balance between interest rate and money supply to keep the money market equilibrium. In addition, from the above graph, it can also be interpreted that the increase in the interest rate has a substantial impact on the investment as due to shift of r0 to r1 cause shift of I0 to I1 or decrease in the investment. Furthermore, it affects the price and output level as aggregate demand curve shifts from AD0 to AD1 due to the decrease in the price and output level (Smith, 2015).
To summarize the above discussion, it can be stated that the UK government can use both fiscal and monetary policies as per their appropriateness to temporary induce economic growth.
On the basis of above explanation, it can be summarized that long-term supply side economic policies can be used by the government for supporting the economic growth in the country. It is because these policies support in developing employees' skill and knowledge level resulting in improved productivity and output level. In addition to this, by reducing tax, the government can also support new businessmen and facilitate economic growth. Moreover, it can also be concluded that the UK government can also use fiscal and monetary policies to temporary stimulate the economy. It can also be stated that fiscal policy can be used either through reducing taxes or increasing government expanding. In addition, by using automatic stabilizers, discretionary fiscal policy, expansionary fiscal policy, and contractionary fiscal policy, the UK government can apply fiscal policy to stimulate the economy. At the same time, through the use of quantitative easing method, changes in interest rate, and bank rate, the monetary policy can be used by the UK government for ensuring growth in the country.
Anderton, A. (2000) Economics. USA: Pearson Education Inc.
Arnold, R. A. (2008) Macroeconomics. USA: Cengage Learning.
Arora, A. and Gambardella, A., (2005) The globalization of the software industry: perspectives and opportunities for developed and developing countries. Innovation policy and the economy, 5, pp.1-32.
Baumol, W. and Blinder, A. (2008) Economics: Principles and Policy. UK: Cengage Learning.
Bishop, T. (2012) Money, Banking and Monetary Policy. USA: Lulu.com.
Cooper, C. L., and Burke, R. J. (2011) Human Resource Management in Small Business: Achieving Peak Performance. UK: Edward Elgar Publishing.
CTI Reviews (2016) Macroeconomics, Economic Growth, Fluctuations, and Policy: Economics, Macroeconomics and monetary economics. Cram101 Textbook Reviews.
Folsom, W. D. and Boulware, R. (2014) Encyclopedia of American Business. Infobase Publishing,
Geyer, R., Mackintosh, A. and Lehmann, K. (2005) Integrating UK and European Social Policy: The Complexity of Europeanisation. UK: Radcliffe Publishing.
Goggin, G. and Hjorth, L. (2009) Mobile Technologies: From Telecommunications to Media. Routledge.
Gwartney, J., Stroup, R., Sobel, R., and Macpherson, D. (2008) Economics: Private and Public Choice. UK: Cengage Learning.
Harrison, A. (2016) Business Environment in a Global Context. UK: OUP Oxford.
Harrison, R. T. and Hart, M. (2002) Spatial Policy in a Divided Nation. USA: Psychology Press.
Henderson, T. M. (2004) Fixed Income Strategy: A Practitioner's Guide to Riding the Curve. USA: John Wiley & Sons.
Higson, G. (2011) The Global Economy. UK: Economics Online.
Hudson, R. J. (2010) Animal and Plant Productivity. EOLSS Publications.
International Monetary Fund (2001) Bulgaria: 2000 Article IV Consultation and Fifth Review Under the Extended Arrangement—Staff Report; Staff Statement; Public Information Notice and News Brief on the Executive Board Discussion; and Statement by the Authorities of Bulgaria. UK: International Monetary Fund.
Jaffe, A.B., Newell, R.G. and Stavins, R.N., (2005) A tale of two market failures: Technology and environmental policy. Ecological economics, 54(2), pp.164-174.
Loayza, N.V., Ranciere, R., Servén, L. and Ventura, J., (2007) Macroeconomic volatility and welfare in developing countries: An introduction. The World Bank Economic Review, 21(3), pp.343-357.
Madura, J. (2014) Financial Markets and Institutions. USA: Cengage Learning.
Makki, S.S. and Somwaru, A., (2004) Impact of foreign direct investment and trade on economic growth: Evidence from developing countries. American Journal of Agricultural Economics, 86(3), pp.795-801.
McEachern, W. A. (2008) Macroeconomics: A Contemporary Introduction. USA: Cengage Learning.
McEachern, W. A. (2011) Macroeconomics: A Contemporary Introduction. USA: Cengage Learning.
Pearson, C. S. (2000) Economics and the Global Environment. UK: Cambridge University Press.
Peng, X. (2015) Financial Theory: Perspectives from China. USA: World Scientific.
Pika, J. A., Maltese, J. A. and Rudalevige, A. (2016) The Politics of the Presidency. USA: CQ Press.
Porter, M.E., (2000) Location, competition, and economic development: Local clusters in a global economy. Economic development quarterly, 14(1), pp.15-34.
Rabin, J. (2001) Handbook of Monetary Policy. USA: CRC Press.
Riley, G. (2005) AQA A2 Economics Module 5 & 6 Digital Textbook. Tutor2u Limited.
Smith, P. (2015) OCR A Level Economics, Book 2. UK: Hachette UK.
UK Government Policy Paper (2015) 2010 to 2015 government policy: UK economic growth. Available at: https://www.gov.uk/government/publications/2010-to-2015-government-policy-uk-economic-growth/2010-to-2015-government-policy-uk-economic-growth [Accessed: 4th May 2017].
Vasigh, B. and Fleming, K. (2016) Introduction to Air Transport Economics: From Theory to Applications. UK: Routledge.
Wacziarg, R. and Welch, K.H., (2008) Trade liberalization and growth: New evidence. The World Bank Economic Review, 22(2), pp.187-231.
Wetzstein, M. E. (2013) Microeconomic Theory: Concepts and Connections. UK: Routledge.
Wilkinson, A., Bacon, N., Redman, T. and Snell, S. (2009) The SAGE Handbook of Human Resource Management. USA: SAGE.