Britain's economic problems are many fold, currently suffering from the effects a recession, which is two consecutive quarters of negative growth. This has caused the value of the pound to depreciate significantly. Many companies and industries also were seen to go bankrupt, some may have been because of a lack of demand as people lost confidence and began to save. Although there are many problems in the British economy today, there are also some ways in which the British government could solve or at the very least ease these problems.
Firstly the government will need to decrease the output gap by increasing AD, this is knows as actual growth or short-run growth. They could achieve this by the use of Fiscal policy, this is changes in government spending and taxation in order to alter AD. The government is doing this now by implementing the car scrap scheme. However this will depend on the size of fiscal expansion, as if it is too big then the economy may pick up rapidly causing AD to outstrip LRAS on the Keynesian diagram, as a result causing rapid inflation. Although this is a possibility there will also be the benefit of increasing employment as a result of rising AD.
This is Keynesian's fiscal expansion to kick start an economy. On the other hand this will also increase the budget deficit and is not a very likable option for politician but is necessary to pull an economy out of a recession. The government could also implement monetary policy, this is changes in the money supply and interest rates and exchange rate in order to alter AD. The British government has done so by slashing interest rates to almost 0.5% from 5% and has also printed more money and depreciated the pound. This should increase spending and investments and therefore pull the economy out of recession.
However because of the recession consumer confidence has fallen dramatically as people and businesses are worried about their future and begin to save instead of spending. Banks are also worried and are very reluctant to lend thus causing the slashes in interest rates to be almost useless. Although this is not very effective during a recession this still helps a little. The best method for a government to implement right now is fiscal policy, this will be the most likely cause for us to pull out of this recession. Only when government spend will we be sure to have extra spending which will work via a multiplier effect, which is the enlarged impact on national income of a smaller change in an injection or spending.
The government can reduce unemployment when in recession by creating new modern industries to replace old jobs. This will benefit us as we will produce more high value products, we already specialise in pharmaceuticals, aeroplanes and chemicals etc.
This can be done by the government providing various companies with government grants, which will aid them in expanding. Although this is a very effective method of increasing the employment rate in the UK, this will take many years to accomplish and 3 years will not be enough. This also conflicts with the budget deficit, as this extra spending will add to our country's deficit and put us further into debt. However this is not a major problem as when the economy returns to is booming state it will be able to pay back these loans, and the deficit is not a major problem as countries are still lending us money and we are far from becoming bankrupt.
The government has also reduced the value of the pound in order to increase our exports and via the multiplier. This will help to increase AD and therefore close in the output gap that we are suffering from now. However this is not as simple as it seems as countries are still not switching demand to us even after the depreciation of the pound by 25%.
The reason being that other countries are also in recession and are being forced to purchase cheaper domestic goods due to their low disposal incomes and also because their currencies may have depreciated causing imports to become expensive. Therefore this is very ineffective in a global recession, like we are having now as demand will not switch to us. Via the multiplier and the accelerator, which is the enlarged impact on current investment on any rate of change of national income.
Both of these work hand in hand as the multiplier is an enlarged impact on Y whereas the accelerator is and enlarged impact on I of a rate of change of Y. Both of these can either cause an economy to go into a deeper recession or they can aid an economy out of a recession. However these two do not cause a recession or a boom they just enforce it. The effectiveness of the accelerator depends on many factors. In the recovery 2009/10 there is such so much spare capacity that a small change in national income will probably have no accelerator effect. Secondly investment decisions depend crucially on confidence.
Business confidence is very fragile and low at this very moment and are very unlikely to invest until they see strong recovery for a couple of years i.e. 4% not the 1% that we may see in 2010. The accelerator will not work at the moment because bank lending has frozen to a halt. Most investment by firms depends on bank loans, also firms can also make do with old machinery and buildings when times are uncertain and with the time lags of 2 to 3 years before firms can build new capacity we should not expect the accelerator to work until we are in at least 2 years of recovery.