Monetary and Fiscal Policies in the UK

Table of Contents

Introduction

Fiscal and monetary policies in every country are the two major tools to sustain macroeconomic stability and to ensure the functioning of the state. These two policies differ and use different inventory; however, their interconnectedness and hence the necessity to carefully interrelate them has been proven long ago, thus substantiating the importance of their joint studying. To ensure a clear understanding of both policies it is necessary first of all to define their differences and commonalities and to proceed to the discussion of the chosen country that is the UK for the present paper.

Monetary policy definition

Monetary policy is the policy for which the Bank of England is responsible in the UK. It concerns controlling the macroeconomic situation with the help of coordinating interest rates and providing for the low rates of inflation. According to the official definition,

The Bank’s monetary policy objective is to deliver price stability – low inflation – and, subject to that, to support the Government’s economic objectives including those for growth and employment. Price stability is defined by the Government’s inflation target of 2% (Monetary Policy Framework, 2009).

As one can see from the present quotation, it is the government of the UK that sets the goal for the Bank of England to pursue. The major aim is to sustain a low level of inflation, which is achieved using manipulating the interest rates, decisions on which are made by the Monetary Policy Committee. Other objectives set out by the government for the monetary policy to achieve are “reduce unemployment, avoid large deficit on current account balance of payments” (Monetary and Fiscal Policy in the UK, 2007).

The description of fiscal policy

Fiscal policy is another macroeconomic tool that is generally enacted by manipulating the government budget balance, that is, the difference between government spending and government revenues with the help of taxes. The budget balance consists of the positive element of tax revenues that are added to the budget and create a surplus and government spending (on salaries to government workers, maintenance of public utilities, provision of medical and social care, etc.) that creates a budget deficit.

If the deficit grows the state takes money from the Back of England, increasing the inner debt, or creates new money supplies, creating the situation of inflation. To save the government from increasing deficit the state may use a tool of raising taxes thus increasing the revenues volume. Government borrowing also results in rising interest rates, which shows the interrelation of monetary policy with fiscal policy (Fiscal Policy, 2009).

On the other hand, one can also track the counter-influence: in the case of rising interest rates, the government spending on producing the interest payments to the Bank of England also rises, thus causing the budget deficit to rise. As a result, there is a set of measures left for the government to compensate the deficit – either to raise taxes or to cut their spending on some spheres of social care provision. Both variants will negatively influence the welfare and material wellness of the nation.

Fiscal policy rules

To create some restraining and controlling rules that would stipulate the limits of acceptable government borrowing there have been created two golden rules of pursuing the fiscal policy in the UK. The first rule concerns borrowing – it should be conducted not to provide for the current spending of the country but only with the aim of investment. The second thing necessary to remember is that the sustainable investment rule: public sector net debt as a proportion of GDP would be held over the economic cycle at a stable and prudent level (Fiscal Policy, 2009).

Fiscal policy has always been considered to be more preferable in developing countries, whereas the developed countries are thought to pursue a more active monetary policy. However, in the context of the current world financial crisis the UK seems to have returned to fiscal policy:

Fiscal policy is now directed firmly towards maintaining sound public finances over the medium term, based on strict rules. Where possible fiscal policy supports monetary policy over the economic cycle. This approach, together with the new monetary policy framework, provides the platform of stability necessary for achieving the Government’s central economic goal of high and sustainable levels of growth and employment (Fiscal Policy, 2009).

Even such a developed country with a well-balanced economy as the UK sometimes experiences certain failures to balance the macroeconomic policies and fails to gain control over the situation in the country, as it was noted by Ray Barrell and Rebecca Riley in 2004 in their paper “The Impact of Fiscal and Monetary Policy Imbalances on the UK Economy”. The authors noted then that the level of government spending was rising considerably, thus creating more budget deficit and resulting in the probability of higher interest rates, rising exchange rate, and worsening competitiveness, reducing exports and increasing imports, etc. (Barrell and Riley, 2004: 61).

Conclusion

As a result of the present considerations, it is possible to note that fiscal policy together with monetary policy creates a powerful complex tool to influence the macroeconomic balance of every country, not only the UK – however, the main concern that should exist within the institutions responsible for working out these policies is to make them wise, balanced, strategically thought over including their potential effect in the long run.

Bibliography

Barrell, R., and Riley, R. (2004). “The Impact of Fiscal and Monetary Policy Imbalances on the UK Economy”. National Institute Economic Review, No. 189, pp. 61-63.

Fiscal Policy (2009). HM Treasury. Web.

Monetary and Fiscal Policy in the UK (2009). Web.

Monetary Policy Framework (2009). Bank of England. Web.

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