25 marker:
Expansionary fiscal policy - intends to increase AD through lower taxes and more government spending. Injection into the circular flow of income, so national income and AD increases. Recession - negative output gap - economy performing under trend rate of growth - on the shallow/elastic part of the AS curve, so increases in AD will lead to a greater proportionate increase in output than in price level and may lead to no increase in price level if it is on the horizontal part of the AS curve - no demand-pull inflation pressure. So, there is a reflationary effect in the policy. However, due to the multiplier effect - AD may shift multiple times leading to it eventually leading to demand-pull inflation as the economy nears full employment and normal capacity (longer term). Hence, it may not be sustainable in the long term. Furthermore, there are time lags in the policy working - people may take time to respond to lower taxes and also during a recession - animal spirits (business and consumer confidence) is low and pessimism increases in businesses and consumers, leading to possibly no effect or smaller effects in AD as consumption may not rise as much as expected, so the policy may be ineffective. Another evaluation point is the increasing government budget deficit also shown in the extract - shows that eventually the government will need to borrow more money and may tighten the fiscal policy in the future to get rid of the budget deficit so it is not sustainable in the long term (however, this could easily be evaluated again that economic growth means increased incomes for workers and therefore increased tax revenue in the future may reduce the budget deficit itself). The increases in AD lead to lower unemployment levels as labour is derived demand and producing the output requires workers. Another evaluation for this policy is that in the long-term, when economies grow, this may lead to inflationary pressures due to confidence rising and demand-pull inflation occurs. This will lead to the UK's domestically produced goods (exports) seem relatively more expensive compared to its trading partners and imports cheaper in comparison to their domestically produced goods, so the balance of trade worsens and a deficit may increase which is a recurring problem for the UK which has a bad and unstable balance of payments on the current account. Also, the fact that the UK has a high marginal propensity to import may reinforce this issue as when the economy and real income grows, the MPM will incease and more people will import leading to a worsening of the balance of payments on the current account. Therefore, the policy does not meet all the macroeconomic objectives and though it may help the economy out of a recession, it will not be sustainable in the future. It can be well argued that the demand-pull inflation fixes itself through more imports as the price level rises, so AD shifts to the left again - however this remains ceterius paribus and is not likely to occur as consumption will be rising and it takes around 2/3 of the aggregate demand, being the largest component so it will offset any decreases in AD caused by increased imports.
Expansionay monetary policy - decreasing interest rates. Decreasing interest rates means that the cost of borrowing is less and the reward for saving is lower. Therefore, rational consumers within the economy will take this advantage to borrow money now and spend it on goods and services before the interest rates increase again. This is also likely to cause firms to invest in capital goods to improve their productivity and international competitiveness, helping the consumers in the economy through the form of lower prices as the SRAS shifts to the right. The initial increase in investment and consumption can lead to a multiplier effect, again leading to demand-pull inflation eventually, however this can be offset by the decrease in price level caused by the SRAS shifting to the right. However, this requires early investment (in the early stages of the recession) which is unlikely as in the recession, the economy is currently operating under its trend rate of growth and in a negative output gap, there is a lot of unemployed labou and capital, therefore there is tons of spare capacity in the economy - which may deter businesses from investing in capital as they will want to produce the output using the spare capacity, instead of wasting it or using it later - especially in the case of workers as this could lead to boredom and de-skilling, which would decrease their productivity. Furthermore, workers cost less than capital-intensive machines and therefore they are the cheaper method to produce output, especially in a recession when businesses are making losses. In addition, as in a recession - there is a lot of unutilised labour - the labour market is loose - there is excess supply of labour and therefore the businesses can push down wages reducing the power of trade unions and lead to lower costs of production, shifting the SRAS to the right, again reducing inflationary pressures. However, in the longer-term when the business and consumer confidences increase, the sustainable economic growth and rises in national income may lead to the accelerator effect taking place as the national income may lead to a proportionately larger rise in investment by firms, hoping to make profits in the long-term and increasing the productive potential of the economy which will lead to further decreases in price level and make the economy more internationally competitive. So, unemployment is massively reduced and excess supply and labour is absorbed in the process of short-run economic growth, and the underlying trend rate of growth may increase (above 2.5% which is currently its rate of growth in the UK). It would also lead to price stability and possibly the balance of payments improving due to increases in the international competitiveness. However, this would require all exogenous factors remaining constant and no demand/supply-side shocks hitting the economy, as all of these events 'may' happen in the long term and it all depends on consumer and business confidence - the animal spirits determine what happens in the economy and as economics is a social science - policy may not have their intended effects as consumers don't always follow traditional economic theory. In addition, in a recession sometimes - due to low animal spirits, reducing interest rates do not always work - for example in the case of the liquidity trap where interest rates were dropped to zero with not as much demand stimulated as expected, leading to a large opportunity cost in the policy. Also, there are time lags with every policy and the monetary policy may take 18-24 months to work and the economy may have already recovered from the recession by then!
Another option of the monetary policy is to change the exchange rate - through depreciation. The depreciation of the exchange rate reduces the price level of the UK's goods and services, making them more internationally competitive. This makes their exports more cheaper relative to trading partners and imports more expensive relative to their domestically produced goods. This may lead to an increase in net exports and therefore aggregate demand and export-led growth for the UK, however this depends on the Marshall-Lerner condition and will only work if the sum of the elasticities for the UK's exports and imports are greater than 1 - so if they are both elastic to changes in the price level. Otherwise, the total value of exports and imports may not increase and decrease as wanted.