Sources of Economic Growth

Readers Question: In what way or how do the economic growth possible ? Currently technology and infrastructure are growing apart from Europe esp UK to Asia. Financial stability per family is also sinking ! right (esp to white people-majority ) Then where is growth of economy and how it drives UK to a new positive level of growth ? Now a days people forget to save money and remember how to spend the same? Where is the growth ?

The immediate problem facing the UK economy is a large output gap and decline in aggregate demand. To boost economic growth we need to increase aggregate demand. To increase demand the government and monetary authorities have tried.

  • Cutting interest rates to 0.5%. Lower interest rates should make borrowing cheaper and increase the disposable income of homeowners with mortgages. This should increase consumer spending
  • Cutting tax rates (expansionary fiscal policy) e.g. VAT to 15%. This should increase consumer spending as they have more disposable income and goods are cheaper.
  • Quantitative easing. Increasing the money supply by the Bank of England buying assets from banks. In theory, this should improve bank balance sheets and increase bank lending which in turn will boost investment and spending.
  • Also, the weak pound has helped boost exports

However, it is difficult to increase consumer spending because:

  • After a decade of low savings and high borrowing, consumers have become more risk averse and consumers are now seeking to increase their savings rate. This will limit consumer spending and make growth more sluggish. (see: problem of saving)
  • Also, banks are reluctant / unable to lend as they seek to improve their balance sheets. Thus, the low levels of bank lending is a limit to consumer spending and investment.
  • Also, falling house prices have reduced consumer wealth and discouraged spending. – If house prices stabilise this may enable consumer spending to rise in the future.
  • Also, the tax cuts are likely to expire as the government seeks to reduce the very large budget deficit. In fact, fiscal policy could soon be deflationary which will hold back growth.

In the long term, economic growth will depend on productivity growth and increases in aggregate supply. However, in the short / medium term, growth will be held back by the many factors limiting consumer spending.

I think the growth will come from a period of low-interest rates and a continued policy of quantitative easing.

For more detail see: Causes of economic growth

By on October 14th, 2009

4 thoughts on “Sources of Economic Growth

  1. You give a conventional answer to the question: how do we grow the economy? You rightly mention quantitative easing and the budget deficit and explain how each of these works. I suggest these two can be merged and simplified, as follows.

    In 2009 in the UK the deficit has been roughly equal to the amount quantitatively eased. Deficit equals “1, wealthy individuals and institutions give money to government/central bank machine, 2, government/central bank machine spends this money, 3, government/central bank machine gives treasuries/gilts to wealthy individuals and institutions”. QE equals reversing items 1 and 3. Thus the only NET effect is 2, which certainly should be stimulatory or reflationary.

    I suggest that recognition of this “simplification” (if I’ve got it right) would cut out an awful lot of argument as to whether deficits and QE work, and if so, how. I’d be interested in your views.

  2. At the end you suggest that economic growth will come from a continuation of the current policies of low interest rates and quantitative easing. However, you also pointed out that consumers are unwilling to spend because they’re trying to increase they’re saving rates. I don’t believe that economic growth will come from a period of low interest rates because the demand for money is not significantly effected by interest rates due to the fact that people are using technology such as debit cards and credit cards. Consumers are not going to change their spending habits significantly because most disposable income is concentrated in checking accounts. If anything, low interest rates are only going to encourage consumers to spend less and save more because the returns of having money in banks are less, making consumers poorer.
    In Brazil, there was a period of time that an increase in interest rates coincided with an increase in consumer spending because saving rates were so high. An increase in interest rates meant that consumers were seeing a greater return on their deposits, which lead to increase spending. I believe what happened in Brazil parallels with what is going on in the US and the UK and that the central banks are overlooking this detail (or not). However, there are no savings. Just a concentration of all disposable income in banks. (In other words, the IS curve is very inelastic due to these technologies.)
    A lower interest rate would only benefit bankers. With borrowing so cheap, banks can borrow at the discount rate and lend that money out over many times at significantly higher interest rates at the expense of average consumers. An increase in interest rates would encourage consumers to spend more, and perhaps encourage bankers to stop taking overzealous speculations.

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