Tuesday, March 24, 2009

What we Have Tried to Boost Economic Growth

Since the government and monetary authorities realised the full extent of the economic downturn in mid 2008, there have been a wave of policies trying to reverse the economic downturn.

Interest Rates.

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
However, interest rates have had limited impact because:
  • 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
2. Fiscal Policy

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
3. Bailout for Banks

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.


Anonymous said...

What is toxic debt and why would America be keen to purchase it?

supernova said...

I believe toxic debt refers I to assets (e.g. mortgages on houses) whose risk of default has been badly underestimated by financiers.
The "Obama plan" consists in allowing banks to sell those risky assets at a lower price decided by a standard private investors' market.

The market value of the toxic debt is reduced through a financial direct contribution from the government and by the promise of an insurance cover by the government should too many toxic debt go bad (default).

What I am not too sure about is whether the government will ever see some of its investment into toxix debt back...

Tejvan Pettinger said...

Toxic assets