Section 1: Macroeconomics
Explain what is meant by the term ‘inflation’ and outline the policies used by the government to achieve its inflationary target.
There are four macroeconomic policy objectives that a government pursues: high and stable economic growth, low unemployment, low inflation, the avoidance of balance of payments deficits and excessive exchange rate fluctuations. Some of these policy objectives may conflict with each other depending on the priorities of the government. A policy designed to accelerate the rate of economic growth may result in a higher rate of inflation and balance of payment deficit.
Throughout the fifties and sixties, rates of inflation were generally low in the advanced industrialised economies. In the early seventies, inflation rose dramatically. By the end of the decade, many governments regarded inflation as the most pressing of their economic problems. Then with the world recession of the early eighties inflation began to fall, only to rise again with the boom of the late eighties, but fell back with the recession of the early nineties. Since then, inflation has stayed low in most countries.
Inflation is a general rise in prices throughout an economy. The government aims to keep inflation low without affecting other policy objectives. If they are unable to do this, the country will lose international competitiveness, lower export and higher imports. If inflation rises, the government will need to increase interest rates to counteract. Raising the interest rates damages investments, business confidence and employment.
Policies that a government may adopt depend on its order of priority. If the government makes the fight against inflation as its major short-term objective, it may be prepared to accept a lower rate of economic growth and a higher level of unemployment.
There are two elements of anti-inflation policies; demand-side policies which are designed to affect aggregate demand and supply-side policies which are designed to affect aggregate supply.
A demand-side policy contains two types; Fiscal policy involves altering government expenditure and taxation, and Monetary policy involves altering the supply of money in the economy or manipulating the rate of interest. Fiscal policy can reduce aggregate demand by cutting government expenditure or by raising taxes which results in reducing customer expenditure. Monetary policy can reduce aggregate demand by reducing the money supply, thereby making less money available for spending or by putting up interest rates and thus making borrowing more expensive.
Supply-side policies aim is to reduce the rate of increase in costs. This will help reduce leftward shifts in the aggregate supply curve. This can be done either by restraining monopoly influences on prices and incomes or by designing policies to increase productivity.
Section 2: International Economics
Should the UK join the single currency? Write an essay outlining the arguments for and against entry.
This argument will probably be the most important economic and political decision Britain will have to make in the first half of the twenty-first century. It could lead to greater prosperity, lower inflation, more jobs and greater national influence. On the other hand, it could lead to higher unemployment, failing businesses and a loss of national sovereignty. Pro-euro and anti-euro arguments not only discuss the effects on business, the economy and our sovereignty, but on personal finances, mortgages, pensions and house prices.
The single currency will directly affect our exchange rate and interest rates and, indirectly, jobs, trade, investment and economic growth. The main cause for concern is the standard interest rate that will be imposed across the continent by the European Central Bank in Frankfurt. If Britain’s economy is ever out of step with the rest of Europe, interest rates will be wrong and put Britain back in to a boom and bust scenario.
By joining the euro we will be entering the largest single market in the world outside the US. This will enable businesses to sell more widely, achieving greater economies of scale. It will also enable families and businesses to buy from a wider and cheaper range of suppliers. Both of these will boost trade and increase Britain’s prosperity.
Britain is the world’s fourth-largest economy, in the best condition it has been in for generations. Britain’s flexible labour market and low taxation helped push unemployment and inflation to the lowest level for a generation. After the boom and bust of the seventies, eighties and early nineties, Britain has at last long-term economic stability. As a low-tax, flexible economy off the coast of mainland Europe, Britain is proving increasingly attractive to foreign investors.
Joining the euro will affect everyone, but businesses will have to adapt the most. Importers and exporters will be greatly affected by the merging of the British and European currency. Staying out of the euro, will lead to the loss of thousands of jobs as foreign investors stay away and British businesses become relatively uncompetitive compared with their European rivals. Without access to the single currency zone, foreign investors who are here will move out, closing factories and businesses, and setting up new ones in mainland Europe in preference to the UK. If Britain rejects the euro, many multinational companies may invest elsewhere. The huge economies of scale of the vast single market of Europe will enable them to produce more goods at lower prices, undercutting British companies at home and abroad.
Joining the euro would involve a major surrendering of sovereignty and severely hindering the governments’ ability to run the economy as it sees fits. Britain would lose control over interest rates and the ability to mange the economy through taxing and spending, and would be accepting direct and explicit legal constraints.
For Britain, it will mean ditching what is probably the oldest continuous currency in the world. The British have a far more historical, cultural and political attachment to their currency compared to any other nation within Europe. The pound sterling is a major national symbol, and the loss of it will be a severe blow to British identity and culture.
Adopting the euro would mean an entirely new set of prices, new coins and notes. Although consumers would suffer confusion initially, this can be reduced by a period of dual pricing followed by a period of dual circulation. This will give customers sufficient time to get used to both the new prices and new currency.
Cash points, tills and vending machines will all have to be changed or simply bought anew. Accounting systems will have to be switched, and staff retrained. The British Retail Consortium estimates that it would cost shops ï¿½3.5 billion. This is though a one-off cost that will not be repeated. It can be looked as just simply bringing forward an investment rather than a whole new cost. Some British businesses have already converted its operations to the euro, as many exporters now have to price their goods in euros rather than pounds to encourage sales from Europe.
To conclude, there are many pro-euro and anti-euro arguments with clear benefits and costs to either course of action. The obvious benefit is that Britain is involved within the second largest single market in the world and not at risk of losing foreign investors. The biggest concern about joining the euro is undoubtedly the loss of sovereignty, reducing the governments’ ability to run the economy and the set interest rate for the whole continent. The ultimate question that will be endlessly discussed is: do the benefits of joining and the costs of remaining outside of the euro outweigh the costs of joining and the benefits of remaining outside?