The Financial Crisis of 2008
The Financial Crisis of 2008 was as a result of deregulation of Financial Markets in the U.S, the U.K, and other Western European economies (Davies, H. 2010, 8) (Rant, Wilson, " Foundation, 2012, 16). Property prices rose steadily and this was profitable for banks and other mortgage markets. However, defaults on mortgage loan repayment rose as a result of an increase in the rate of unemployment. Banks faced liquidity problems and the systematic risk also increased. Large banks, as well as the government, stepped in to provide financial support to other smaller affected financial institutions and building societies. Some banks in the U.K were nationalized while others were forced to raise capital by issuing new shares. Interbank lending rates rose resulting in a reduction of both personal and corporate credit. Retail sales dropped while the unemployment rates rose. This resulted in a reduction of government revenues through taxes.
The UK Government's Austerity Policy
The UK government adopted the Austerity Policy in a bid to reduce government debt. This is done through spending cuts, increase in taxes, or a combination of both and raised serious criticisms by some commentators that argued that reversing the stimulus could deepen depression and delay recovery. In 2009, the UK experienced a period of recession, which had a huge impact on its public finances resulting in budget deficits (Berry 2016, 45). Taxes rose and big cutbacks on spending especially on new schools, hospitals, and roads. In this paper, we will assess views in favor and against the austerity policy for the UK economy. We shall also illustrate how the Monetary and Fiscal Policies interacted in the UK economy in the period after the Financial Crisis.
Views In Favor Of the Austerity Policy
The Financial Crisis resulted in an increase in the national debt (Dimsdale " Hotson 2014, n.p). Austerity measures needed to be adopted to reduce this debt. There are some of the arguments in favor of the UK government adopting austerity measures. Firstly, the fiscal conservatives argue that the austerity program will boost confidence among domestic and foreign investors. Austerity measures are intended to reduce the Budget Deficit, which boosts investor's confidence that the economy will perform better in the long run. Secondly, the policy would help maintain the UK's international Credit Rating, which would assist to reduce the Interest Rates on Bonds. Cutting budget deficits would help to reduce bond yields. Higher bond yields and interest rates on other bonds would reduce the private investment.
Also, the fiscal conservatives argued that since the policy was successful in other countries, it would also work for the UK. An example of a country where the policy was applied and was successful was Canada. The policy was applied in Canada between 1993 and 1996 after which the country managed to maintain strong economic growth (Kelsey 2017 p.143). Lastly, they also argued that it was morally right for the country to spend only what they have. This is because a debt arises as a result of the government spending being greater than the tax revenue in the given time period.
Views against the Austerity Policy
Firstly, the government cut its spending such as through wage freezes and welfare cap, which negatively affected the lower income families. The net income of the poorest fraction of the population was cut. This would increase both the absolute and relative poverty levels and in turn worsen the inequality levels in the UK (Cooper " Whyte 2017, 142). Secondly, the Austerity Program negatively impacted the unemployed proportion of the population. The small increase in taxes and cuts in welfare would worsen the situation of the unemployed. Thirdly, the policy resulted in an increase in demand for government bonds, which resulted in a liquidity trap as there is a rise in the private sector saving. On the other hand, bond yields continue to decrease.
Another argument was that cuts in government spending result in a fall in aggregate demand. In a period of recession, private sector consumption and investment are lowered. Adoption of the Austerity Policy would therefore not assist in maintaining demand. The fifth argument against the Austerity measures is that other countries such as Greece and Spain that adopted it did not achieve to stop the rise of bond yields. Thus, it resulted in a shrinkage of these countries' economies. Austerity measures applied in these countries resulted in lower economic growth due to reduced tax revenues, which resulted in a fall in this countries' GDP. Lastly, several economists argued that austerity should not be applied in times of recession (Nanto 2009, 163). This is because cutting on spending does not boost the confidence of the affected country's economy. The reduced confidence, in turn, increases the unemployment rates making internal devaluation to take longer.
How The Monetary And Fiscal Policy Interacted In The UK Economy In The Period After The Financial Crisis.
The Monetary and Fiscal Policies are stabilization policies. The Monetary Policy refers to how the Central Banks of the various countries control the short-term borrowing to ensure price stability so as to maintain a healthy economy (Walsh 2010 p.19). The Fiscal Policy, on the other hand, refers to the way the government influences the economy by adjusting its spending levels and tax rates (Alesina " Giavazzi 2013 p.12). We seek to illustrate how these policies interacted in the UK economy after the financial crisis.
The Financial Crisis led to a decline in inflationary pressures and a decline in loan interest rates charged by banks. The Bank of England decided to counteract this effects by lowering the policy interest rates. They adopted a Fixed-Rate Full Allotment, which gave banks as much liquidity from the Central Bank as they wanted. These measures ensured that there is a constant supply of credit and reduced the emergence of Systemic Risk.
These measures increased the Eurosystem's balance sheet corresponding to a higher level of outstanding refinancing operations. They resulted in inflation stability, which promoted economic welfare. The Monetary Policy made an important contribution to macroeconomic stability. The Medium-Term Orientation Strategy adopted ensured that timely action is taken to address any potential threats to Price Stability. Fiscal authorities in the government announced national measures to support the banking system. These included asset relief schemes, guarantees for interbank lending, and an increase in the coverage of retail deposit and insurance.
The Adaptation of the fiscal policies also resulted in rising Long-Term Government Bond Yields. The growing yields were as a result of investors' reduced willingness to invest in the economy, which resulted in a decrease of the budget deficit to above 3% of the GDP reference value (Kirkland 2017, p.32). The UK need not adopt additional fiscal policies as they would fuel concerns about the country's ability to meet its future debt obligations. Increasing budget deficits would not only result in an increase in Interest Rates but also a huge tax burden in future. Consumers appeared to spend less while in turn saving more due to future uncertainties.
Both the Monetary and Fiscal Policies were successful in safeguarding the stability of the financial system. They helped to restore the lost confidence in the UK economy. The private investors responded positively to the tax policy adopted thus investing more.
Conclusion
The financial crisis that took place in 2007 as a result of sub-prime mortgages dealt a huge blow to Western economies. The UK economy was no exception. Austerity measures needed to be adopted with an aim of reducing the government debt. Some economists were for the idea of the adaptation of austerity measures while others were against the idea. In addition to adoption of austerity measures, monetary and fiscal measures also needed to be adopted. The two proved a success as they assisted in stabilizing the UK economy. The monetary policy anchored inflation consistent with price stability. The crisis demonstrated the need to have sound public finances and the need for government imposing regulations to ensure the health of a nation's economy.
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