Introduction
Government economic policies have been known in the world over to take shapes depending on the economic situation at the given times. Major drivers of shifts in economic policies include the desire to control high rates of inflation, control levels of exchange rates and ensure stability of currency. The purpose of this economic essay is to analyze aspects of government economic policies in regard to balance of payments, inflation and exchange rate and explore a variety of issues that pertains to the above three aspects.
Balance of payments
Balance of payments in this context refers to a collection of UK government’s economic activities with other countries. McCombie and Thirlwall (1994) present a broad definition in stating that “balance of payments is the measurement of a country’s economic transactions with the rest of the world.” It consists of three components that include the current account, the capital account, and the overall account. The country comes to a state of external equilibrium in a situation the balance of payments is at a sustainable level.
Balance of payments may not necessarily be bad for the economy. “If a country is importing a high volume of goods and services, balance of payments acts as a short-term boost to living standards since it allows consumers to buy a higher level of household durables and other items” (Olumuyiwa, Jagdish & Alexander,1994). Whereas a number of economic policies may be instituted to address the problem of a balance of payments deficit, a number of factors must be considered. These include size of the deficit, how long it has lasted and factors that have caused it. This is because the capacity to reduce payments deficits depend on what has caused it. Payments deficits precipitated by a high trade deficit is an excessive level of aggregate demand may not demand swift policies in that it may improve automatically in the event of an economic recession. This is because of the slowing down of the real incomes and spending. Deficit precipitated by supply-side economic weakness require policies that can improve our cost and non-price competitiveness. Economists consider persistent balance of payments deficit to be dangerous for an economy. This is because “it is a symptom of a weakening domestic economy and a lack of international competitiveness – pointers to declining living standards” (Salvatore, 1991).
Inflation
Inflation may be defined as persistent increase in the general prices of products in the market. Majority of economists consider inflation to be dangerous for an economy because of its effect in the reduction of money value and the falling of money incomes. This will negatively impact on the purchasing power of the citizens. In addition to the above, higher rates of inflation will lead to gaining on the part of borrowers while savers will lose. Last, international competitiveness will wane down because our exports will definitely appear unattractive in the international market. This discourages foreign investors in capital and financial investments because of the uncertainty.
The United Kingdom’s may apply a variety of policies to control the rates of inflation. These policies are divided into three significant areas. These include the fiscal policy, monetary policies and supply side policies. Fiscal policy refers to “a change in the levels of government expenditure and taxation to try to influence economic activity” (Salvatore, 1991). The government can increase its own spending by cutting down taxes and thus injecting a boost of spending in the economy. This will enable it to absorb more resources. Monetary policy on the other hand “is the use of interest rates and money supply changes to manage the overall level of demand in the economy and therefore help achieve the economic objectives” (Salvatore, 1991). Last, the supply-side policies are designed to make aggregate supply (AS) more responsive to changes in national income. A combination with other policies will deliver a competitive economy.
Exchange Rate
According to Salvatore (1991), “this is the price of a currency in terms of the other.” The three types of exchange rate systems include fixed, floating and managed (dirty float). A number of factors that have the capacity to influence the exchange rate include the interest rates, world trade, demand for imports and exports, political factors such general elections and the probable trends of inflation.
The fixed advantages of exchange rate system include a reduction in the uncertainty of all economic agents in the country and a reduction in the speculation in the foreign exchange markets. The fixed disadvantages of exchange rate system is the deflationary effect on the economy that may lead to increase in demand and decrease in employment. In brief, the advantages of exchange rate system include reduced risks in international trade, the introduction of discipline in the economic management and the elimination of destabilizing speculation. The disadvantages on the other had include lack of automatic balance of payment adjustments, the requirement of large holdings of foreign exchange reserves, lack of freedom in the internal policy and unstable fixed rates.
Conclusion
It can be discerned from the above discussions that balance of payments, inflation and exchange rate constitute major drivers in the UK economy just as in other nations. The government has immense powers to influence these policies to remain economically competitive in the international sphere.
References
McCombie, J. S. L and Thirlwall, A. P. 1994. Economic growth and the balance-of-payments constraint. New York: Palgrave Macmillan.
Olumuyiwa S. A., Jagdish H. and Alexander, B. D. 1994. The balance of payments analysis of developing economies: evidence from Nigeria and Ghana. Lagos: Ashgate Publishing.
Salvatore, D. 1991. National economic policies. London: Greenwood Publishing Group.