What is the main economic issue?
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The main economic issue that is facing Britain is the threat of a recession reoccurring. The imminent recession that is facing the Euro region is fast spreading into Britain. Banks in Britain are finding it hard to find money to refinance their debts and this is causing them to dispose of many of their assets at a very alarming rate. The banks are doing this in the view of meeting the EU capital adequacy targets set for June 2012. Banks in Britain are caught in a difficult situation owing to the massive debts they loaned to businesses and governments who are much affected by the Eurozone financial crisis. This has also been in part been caused by loans extended to banks in German and France who are on the verge of default. Plans made by many Euro-zone countries to cut on their budgets are also affecting banks and financial institutions in the country and causing many businesses in Britain to suffer a severe credit shortage making them cut their spending and expansion plans (The Economist).
Britain is also facing economic issues resulting from within the country rather than influence from the International Markets. The spending power of the population has been eroded and the growth of wages is half the level of inflation. Many families in the country are being forced to dig deeper into their savings as they try to cover costs. This has made many of them apprehensive about their spending, which makes them cut on their spending. The population is cutting down on spending and this has in turn affected the demand for most products prompting many companies and industries to cut down their workforce (The Economist).
The country is mainly relying on earnings from exports and this has been severely affected owing to the fact that two-fifths of the exports are consumed in the Eurozone, which is experiencing an imminent recession and financial troubles. Exports to the euro region have reduced drastically as most people in the region try to reduce their spending. Workers are losing their jobs and this further complicates the financial situation in the country because many of them cannot now meet their financial obligations and are forced to default. The Bank of England is being forced to use newly created money to buy bonds (“quantitative easing”) more than the agreed value of £275 billion as it tries to avert a recession. The country is also facing a deficit of GDP is also another economic issue that is dogging the country’s government as is estimated to stand at 8.4% at the end of this fiscal year (The Economist).
How is the economic issue related to Macroeconomic concepts or models (i.e. GDP, etc.)?
The risk of the country experiencing a recession is related to various concepts of macroeconomics. A recession occurs when there is slow growth in the economy as a result of a drop in consumer demand. When the sales decrease, businesses do not grow and as a result, they stop employing new workers. The effect of the recession does not begin until workers start being laid off. As the rate and number of unemployed increases, the purchasing power of the population reduces drastically. The first indicator of a recession will be seen mostly when the housing prices begin to fall and many people begin to default on the payment of mortgages and loans. When there is no economic growth in a country, the gross domestic product decreases. The gross domestic product is defined as the market value of all the finished goods and services that a country produces in a given time. When the gross domestic product is calculated per capita it usually will be an indicator of the standard of living of a country.
The Euro region consumes two-thirds of the exports coming from Britain. Because of the financial crisis experienced in the Euro region, demand for produce from Britain has and is expected to decrease. This has caused a decrease in the gross domestic product of the country and thus further complicating the economic outlook. Homeowners in the country are finding it hard to dig deeper into their pockets to cover the high-interest rates on mortgages, while at the same time trying to cover the high inflation rate being experienced. Workers are also being laid off and this is especially true for those working in the financial district. The workers in this region are being laid off as the fees and commissions previously enjoyed are becoming rare. All these things paint a gloomy picture of the financial situation in the country. When the macroeconomic concepts such as inflation, output (Gross Domestic Product), and unemployment move in the direction, they are moving in the country it may be signs of a recession looming.
What sorts of arguments/opinions have been discussed?
The author of the article criticizes the optimistic view the Office of Budget Responsibility has on the economy of the country. The opinion of the author is that the country has all the signs of an imminent recession although the OBR is being too optimistic. The author argues that the financial problem facing the country does not only stem from the euro crisis, but also from domestic influences such as high inflation rates and low wage growth.
The author points out the problem of the government using newly created money to tackle the problem of inflation. The government plans to spend over £275 billion of newly created money. Using newly created money to tame inflation is good for the short term, but in the long run, it may pose a threat to the economy. The author is of the opinion that this move is unlikely to prevent the economy of Britain from shrinking two quarters. This can be considered a recession if it happens. The author continues and says that the second dip of the recession should be shallower than the first. This is because there is little excess to be affected than in the first occurrence of recession. The author says that it is possible that the output of the country may reduce by 1% and the recovery from this will take a long time.
The article argues that the current government inherited a lousy financial system that is becoming difficult to handle. It looks at the competence of the Chancellor of the Exchequer, Mr. Osborne, and the strategies that the government is adopting to tackle the financial problems that are facing the country. The article joins in accusing Mr. Osborne of being too optimistic when he claimed that, “an aggressive fiscal tightening would show immediate benefits by promoting growth, rather than depressing demand.” It, however, praises his actions and the author is of the opinion that Mr. Osborne was right to make these changes in 2010 because it has helped to reduce the budget deficit, which in the 2009- 2010 period stood at 11.2% of the Gross Domestic Product. The author argues that the decision of Mr. Osborne has helped reduce the deficit to 8.4% of the gross domestic product this year as well as allowing Britain to gain the trust of credit rating agencies and bond markets, which allows the country to retain its AAA credit rating and borrow cheaply compared to other rich countries.
The author continues to argue that although Mr. Osborne is committed to bringing the financial situation in the country under control there are several things he could do without jeopardizing the financial credibility of the country. The author’s opinion is that investment in infrastructure should be targeted at improving the supply potential. He disagrees with the proposal made by Mr. Balls who advocates for a tax cut. The author is of the opinion that the success of the scheme proposed by Mr. Osborn lays on the take-up by cautious banks and nervous small businesses.
Do you agree or disagree with the analyses/opinions? Why?
I strongly agree with the analysis made by the author and the schemes proposed by Mr. Osborne. The plan by Mr. Osborne to create growth by using private savings to pay for infrastructure ventures is appropriate. The advantages of using the private sector to fund projects are many, but in this case, the most important advantage is that it would help the government to reduce its debts. Private capital helps and allows the government to reduce the amount of interest incurred on loans and this money can be used to finance other projects. It also means that people are not heavily taxed and, therefore, their purchasing power is not reduced. Another advantage of using the private sector to fund projects is that the government is able to create jobs for the population and thus tackle the problem of unemployment.
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The author is right to disagree with the proposal made by Mr. Balls. This is because “Reductions in federal taxes will tend to finance more private consumption, as will increases in spending for federal entitlement programs. Increases in current federal purchases (which do not include public investment) will raise government consumption” (CBO). This would only solve the problem for a short time and the public would be eager to take advantage of the cuts by consuming more. This in turn will reduce the saving power of the people and therefore there will be less money to invest in the future. This would make a recession and the risk of recession a cyclic cycle where the government would be forced to offer more tax cuts after a period to sustain the economy. To tackle the financial problem facing the country the government should adopt the model proposed by Mr. Osborne of increasing the private sector involvement in infrastructure funding and development. This would allow the government to spend the extra money on other projects such as social reforms, medicine, and education.
What arguments would you, as an economist, make?
Budget deficits decrease the buying power of the people and reduce their standards of living. It slows down the accumulation of national wealth because the saving power of the people is reduced. The budget deficit hurts the savings by the nation by shifting the resources into consumption by the government and private sector through an increase in spending by the government and tax reduction. These impacts on the saving power of a nation can cause low labor productivity by decreasing domestic investment. Although income from exports helps to mitigate this, it is not always good to rely solely on the exports to sort out financial problems in a country. As can be seen in the article the reliance of Britain on exports to help clear the financial problem is at risk of being unhelpful, because one of its largest consumers the Eurozone is having a financial problem of its own and therefore consumption is expected to lower in the region.
My argument is that the government should adopt strategies that help in controlling consumption and increasing the savings of a country. The private sector should be encouraged to invest in infrastructural projects, and this can be done through subsidies. The government should also put in place policies and schemes that are aimed at tackling the problems caused by inflation. When the inflation rate is high the purchasing power of the people is eroded and they can, therefore, not afford to buy products this will affect the industries as there will be no demand for the goods. This in turn reduces the gross domestic product of the country and the country will be facing the risk of recession. To tackle the problem of unemployment the government should encourage the growth of small and medium-sized industries that will absorb a large number of the unemployed.
CBO. “Long-Term Economic Effects of Chronically Large Federal Deficits.” 2005. Web.
The Economist. “Another recession is on its way. Even so, the government’s policies are broadly right.” Britain’s Economy. 2011. Web.