Outline
This paper analyzes the Keynesian theory of unemployment, reasons for the decrease in the value of the British pound, how the balance of payment can cause inflation in an economy, and finally why the fiscal expansion is more effective with fixed exchange rates than under floating rates. It is therefore divided into the following sections:
Introduction
According to Robert (1998), Keynesian unemployment can be defined as unemployment that arises in a period when an economy is in recession. The Keynesian theory of unemployment was developed by John Maynard Keynes who believed that lack of effective demand for goods and services was a major cause of the high unemployment rate in an economy. In his studies, he discovered that since the employers are being faced with low demands for their products it becomes hard for them to employ people which eventually leads to high levels of unemployment in the economy (Robert, 1998).
According to the Keynesian theory of unemployment, it states that any level of output and employment in any economy comes as a result of Aggregate Demand where Aggregate Demand in a greater sense refers to the total demand for goods and services in any economy. This brings to the conclusion that during such times the government should implement policies that are aimed at increasing aggregate demand (James and Richard, 1984)
According to Robert the (1998), policies which the government may implement in order to reduce unemployment may include; government ensuring high employment of the overall population as this will act as a compensation for the decrease in the levels of wages and labor this will enable the people involved in this employment to have surplus money which can be spent in the economy through the purchase of goods thereby acting as means through some business can be supported, secondly is the government borrowing more money to run the deficits existing in the economy at the same time obtaining money from the people through both the direct and indirect taxes, lastly, the government adapting policies which induce investments through reduction of interests rates and the government heavily investing in infrastructure. Such government investments spending will lead to the injection of income in the economy which further increases spending to the general economy which acts as a stimulation for more production and investment (Robert, 1998).
The Keynesian policies would not be applicable in a situation where structural unemployment exists since the people to be employed lack the skills needed by the employers for them to be employed at the same time some firms lack the required equipment to employ some workers. In such cases, the effective demand alone cannot reduce unemployment rather it causes inflation since the Keynesian policies revolve around the cure of excessive unemployment especially in times when the economy is experiencing recession (James & Richard, 1984).
The reasons why currently the British pound is depreciating
Currently, the British pound has been depreciating significantly against the dollar and Euro due to the following reasons; firstly is the stability of both the U.S dollar and the Euro markets, secondly is the weak economic situation and the recent changes in the banking policies in the UK, lastly is the existence of market linkages and volatility spillovers between the currencies (Conklin, 2005). Such causes are believed to be caused by microeconomic news which leads to both external and financial shocks. Furthermore, these shocks are believed to play a fundamental role in the determination of the exchange variables since the volatility of one currency depends on its past and domestic information. This, therefore, implies that the presence of a foreign currency in one particular market actually predicts the volatility in the others (Conklin, 2005).
The impact of balance of payments deficit on inflation
The overall balance of payments deficit in any economy can be seen as a situation that is caused by a shortage of liquidity in an economy. Due to this shortage of liquidity in an economy, it creates a situation where excessive money from a foreign country that has a balance of payment surplus freely flows to the domestic country that is experiencing a liquidity shortage (Poor, 1996). Normally this money will flow inform of investments example could buy businesses, land, and factories. This will create a situation where money circulation increases as the people are access to money freely due to the excessive inflow of foreign currency. The increase in money supply will in the end lead to an oversupply of money in the economy as people are accessible to money easily creating a situation where the money supply is more than demand. This increase in money supply will lead to a decrease in the lending interest’s rates, an increase in the interests being charged on investments, and increase in overall prices of goods and services a situation which in the end leads to an increase in inflation in the domestic country (Poor, 1996)
Why the fiscal expansion is more effective under the fixed exchange rate than under floating
Paul and Maurice (2000), argue that Fiscal expansion can be seen as a fiscal policy that results in the raise of aggregate demand for any given exchange rate belonging to a particularly given economy. A fixed exchange rate is more suitable in increasing the Fiscal expansion of any country because under fixed exchange the government takes all the responsibility to hold the exchange rate at a given fixed value against other foreign currencies like the dollar or euro this creates a situation where the foreign currency has a fixed value which cannot be altered no matter the conditions in the economy (Paul & Maurice, 2000). This actually helps to remove a situation where uncertainties exist especially about the changes or the rate that will be involved when carrying out any foreign transactions. Furthermore, the fixed exchange rates are more effective compared to Under Floating Rates since the under floating exchange rates lead to a balance of payments deficit which eventually leads to depreciation (Paul & Maurice, 2000).
References
Charles Robert (1998), John Maynard Keynes: critical responses; Published by Taylor & Francis.
James J, Richard P (1984), The economics of unemployment: a comparative analysis of Britain and the United States; Published by Cambridge University Press.
Paul R., Maurice O (2000), International economics: theory and policy; Published by Addison- Wesle, 5th edition.
David W. Conklin (2005), Cases in the environment of business: international perspectives; Published.
Charles Poor (1996), World economic primacy: 1500-1990; Published by Oxford University Press US.