After a long period of stable interest rates, in the past few months, the MPC have cut interest rates dramatically. From 5% to 0.5%.
In theory lower interest rates:
- Reduce cost of borrowing encouraging investment and spending
- Reduce incentive to save
- Reduce mortgage interest payments and so increase disposable incomes
- Banks reluctance to pass base rate cuts onto consumers
- Banks reluctance / inability to lend because of credit crunch and deteriorating economic prospects
- Recession has made people risk averse and encouraged saving rather than consumer spending
- Inevitable time lags of interest rates
The recession has caused a rise in government borrowing - lower tax rates and higher government spending. In addition the government has pursued expansionary fiscal policy - lower VAT, higher spending. The impact on government finances has been dramatic. The level of government borrowing next year is forecast to top £180bn (very roughly 13% of GDP - a post war record)
Despite huge fiscal stimulus, output continues to fall and unemployment rise. This is because of the powerful factors slowing the economy down:
- Falling house prices
- Decline in output/ jobs in the finance sector
- Time lags
The UK government have effectively nationalised leading banks like Northern Rock and RBS, to prevent banks going under. (bank nationalisation)
4. Purchasing Toxic Debt.
Especially in America, the government / fed have been buying toxic assets to try and improve the balance sheet of American banks - hoping this will encourage more lending. This formed the basis of the Paulson plan and Obama's team seem to have come up with something similar. This policy has been criticised by many - Krugman - calculated risk
5. Quantitative Easing
The UK has started a policy of increasing the money supply to be able to buy assets - corporate bonds and government bonds. The hope is to avoid deflation, and reduce long term interest rates. Some fear quantitative easing will cause inflation. But, at moment there is a large output gap, it is too early to tell the impact of this policy. Quantitative easing
6. Bailouts for Industries
In the US, the government have offered loans and subsidies to the car industry to prevent job losses. In terms of overall aggregate demand, these bailouts are relatively small.
7. Depreciation in Pound
Not really a policy, but, the depreciation in the pound is something that in theory has helped boost competitiveness of exports and boost domestic demand. If the UK was in the Euro, this is something they couldn't have done. The impact of depreciation has been limited by the slowdown in global trade.
Is there any policy left?
Well there is always the helicopter drop - 'dropping notes from the sky'. This could involve giving people vouchers they have to spend by a certain time frame.